For those traders who want a clear and brief explanation
of various concepts often touched on in technical analysis and trading,
we offer Traders' Notes.
ELECTRONIC DAYTRADING
Considering the increased interest in daytrading and our interview with
David Nassar in the May 1999 STOCKS & COMMODITIES,
we thought that some clarification of common terms used in electronic direct
access trading (EDAT) might be helpful.
Archipelago: Also called Terra Nova, this electronic communications
network (ECN) has the symbol of TNTO on the Level II screen.
Bloomberg: An ECN with the symbol BTRD for B-Trade on the Level
II screen.
Direct Access System: This is a generic term for the method by
which individual traders can route and execute orders directly and instantaneously.
This can be done either on the trader's PC from home, or on the premises
of one of the direct access electronic daytrading firms. Secrets Of
The SOES Bandit author Harvey Houtkin uses the term direct access
electronic trading (DAET), Mark Friedfertig and George West use electronic
day trading, and David Nassar used the term electronic direct access
trading during his S&C interview. This access allows the individual
to bypass the intermediaries (brokerage firm, marketmakers, and specialists)
and trade directly via Nasdaq's SOES, NYSE's DOT and SuperDOT, as well
as other ECNs. DOT and SuperDOT are not automatic execution systems and
still rely on specialists to execute the trade. Some benefits of the direct
access method over the traditional method: quicker fills, price improvement
potential, and maneuverability.
Electronic Communications Networks (ECNs): Whereas SOES and SelectNet
are owned and operated by Nasdaq, ECNs are independent execution systems
set up by brokerage firms. These systems match new retail limit orders
with compatible orders already in the system. The significance of these
systems to the individual direct access electronic trader is the ability
to trade inside the spread of the marketmakers' best bid and ask. For instance,
if the Level II screen shows ABCD quoted 15 bid at 15-3/16 ask, you can
enter a bid for 15-1/8 using an ECN. Your bid is then displayed on every
Level II screen as the new best bid until someone betters your bid or someone
hits your bid. Then you pay 15-1/8 for the stock, which is less than 15-3/16,
which you would have had to pay had there been no ECN. And the seller gets
15-1/8, which is more than 15 that she/he would have gotten from the marketmaker.
The trade is also done instantly; no waiting for the order to be routed,
executed, and then confirmed by your broker.
Instinet: The first ECN formed in 1969, Instinet is owned and
operated by Reuters and was initially used only by institutions to display
bids and offers to execute trades for Nasdaq and NYSE stock. Currently,
Instinet is the largest ECN, used by institutions, and generally preferred
by marketmakers, even though they can use any ECN. Some brokerage firms
can arrange for individuals to use Instinet for 24-hour trading outside
of the exchanges, but liquidity is a limiting factor.
Island: Datek Trading's ECN, with the symbol of ISLD on the Level
II screen. Island began in 1996, has been growing quite rapidly, and has
very high market liquidity.
Level II Screen: A display of the two-sided market for each stock
traded on the Nasdaq. Each marketmaker must display the number of shares
and price at which he/she is willing to sell (bid) or buy (ask) stock for
which they make a market. Each screen shows five levels of prices including
Level I, which is the highest bid and lowest asked, known as the inside
market or best market. Each level is color-coded, identifies
the marketmakers, their quotes, and number of shares committed to (that
is, size). The marketmaker providing the best bid does not necessarily
have to be the same one providing the best asked.
Optimark: A routing system for the NYSE, accessible by large
institutions and individuals, with orders of 1,000 shares or more. Institutions
looking to move large blocks of stock but not broadcast their intentions
can do so anonymously on this system. This situation will allow the individual
to participate in the liquidity of large institutional orders and will
provide the potential for price improvement. It is predicted that Optimark
will improve market liquidity in general.
RediSystem: Trading software used at Speer Leeds & Kellogg.
Routing and Execution Systems: Traditionally, an order is given
to a broker, either by phone or over the Internet. It then must be routed
by the broker to the appropriate exchange, either electronically or by
phone. Once at the exchange, it must be executed by the specialist
(the New York Stock Exchange [NYSE]) or the marketmaker (Nasdaq). This
process can result in a substantial delay and an adverse fill price.
SelectNet System: This is a voluntary order execution system
provided by Nasdaq, and marketmakers using this system cannot be SOESed
or automatically executed. The bid and ask display in this system is viewable
only by marketmakers and not by individual investors, even those with direct
access. Only marketmakers can execute the trade, unlike ECN orders. There
is no limit-order protection afforded SelectNet orders, and they are not
displayed on Level II screens. SelectNet provides a convenient negotiation
method as an alternative to the phone, which facilitates trades between
marketmakers. SelectNet can also be used by marketmakers to send each other
short text messages.
Small Order Execution System (SOES): A computerized system developed
by Nasdaq for immediate electronic execution of up to 1,000 shares of stock.
Before the stock market tumble of 1987, this method was not widely used.
To help provide an orderly and liquid Nasdaq market, all marketmakers are
required to honor any display of bid or offer price on orders up to 1,000
shares. Direct access traders are able to instantaneously execute their
order at a known price, without any action from the marketmaker. It is
therefore impossible for a marketmaker to back away from (that is, not
honor) a quoted bid or offer, and the marketmaker who has just been exercised
in this manner is said to have been "SOESed."
SuperDOT: Short for Super Designated Order Turnaround,
this is the NYSE's method for electronically routing and executing orders
for listed stocks. This computerized system first appeared in 1984 as an
upgrade of the previous DOT system used to execute listed stock transactions.
Currently, about 40% to 50% of all shares traded on the NYSE are executed
on SuperDOT, making up about 80% of NYSE orders. Up to 99,999 shares can
be traded on one order, and program trading contributes to the volume moving
through this system. The individual electronic direct access trader can
use either the SuperDOT or the DOT system to trade up to 2,100 shares of
listed stocks. Compatible orders are matched with existing orders on the
SuperDOT system; however, the specialist must actually execute the trade
by pushing a button. Therefore, this is an automated routing system,
rather than automated execution system. Under normal conditions,
it is quite fast and the possibility for price improvement exists.
-- Stuart Evens, Staff Writer
RELATED READING
Friedfertig Marc, and George West [1998]. The Electronic Day Trader,
McGraw-Hill.
Houtkin, Harvey, with David Waldman [1998]. Secrets Of The SOES Bandit,
McGraw-Hill.
Nassar, David S. [1999]. How To Get Started In Electronic Day Trading,
McGraw-Hill.
Originally published in the July 1999 issue of
Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved.
© Copyright 1999, Technical Analysis,Inc.
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