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 DAYTRADINGConsidering 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
Friedfertig Marc, and George West . The Electronic Day Trader, McGraw-Hill.
Houtkin, Harvey, with David Waldman . Secrets Of The SOES Bandit, McGraw-Hill.
Nassar, David S. . 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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