Dr. P.V. Viswanath

pviswanath@pace.edu

Securities Trading

• Types of Orders
• How are orders placed and executed? (NYSE)
• NASDAQ
• Innovations in Trading Systems and Methods
  • Optimark
  • ECNs
  • SuperDOT
  • SOES
  • SelectNet
• Article on Market Structure, Efficiency and Arbitrage by Profs. Handa and Rietz at U. of Iowa

Types of orders

• Market Order
  instructs the floor broker to promptly execute the order at the most favorable price.
• Limit Order
  A buy limit order stipulates that the floor broker executes the order within the limit set by the customer. If it is a sell limit order, the broker cannot sell for an amount less than that stipulated. If the price is touched, it is not guaranteed that the order is executed, since price moves may be rapid.
• Stop Order
  A stop buy order is placed above the current market price and becomes a market order if the price is touched. A stop sell or stop loss order is placed below the current market price.
• Open orders: good until cancelled
  these orders will continue to be placed for execution until cancelled by the customer, or filled.
• Stop limit order: stop orders that turn into limit orders when the stop is exceeded.

Types of Limit Orders

Uses:

• To buy at a specified price or better.

• Used in inactive markets where the possibility of a stray higher-than-equilibrium price cannot be discounted; hence a market order is unwarranted.

Uses:

• To sell at a specified price or better.
• Used in inactive markets where the possibility of a stray lower-than-equilibrium price cannot be discounted; hence a market order is unwarranted.

Types of Stop Orders

Uses:

• Used in conjunction with a short sale to cut losses where it is feared that prices might be headed higher.
• Used for protection against an unexpected jump in prices.

Uses:

• Used to cut losses, by selling existing holdings where it is feared that prices might be headed lower.
• Used for protection against an unexpected slide in prices.

NASDAQ

When trading on a quote-driven exchange, a trader needs to keep in mind several things:

• The Bid quote is the price at which the trader is required to buy the minimum number of shares
• The Offer quote is the price at which the trader is required to sell the minimum number of shares.
• The bid quote is (almost) always is lower than the offer quote.
• The difference between the offer (ask) quote and the bid quote is called the bid-ask spread.
• If the bid quote is higher than the ask quote, then we say that the market is crossed.  
• If the trader has too high an inventory of the stock, he may not want his Bid quote to be the inside bid.
• If the trader has committed to too many sales (short-sold), he may not want his Offer quote to be the inside offer.
• If the market is expecting news, the trader may want either his Bid or his Offer to be the inside quote if he is himself not informed; else, he may be forced to make undesirable trades.
• Watch price trends, so that the trader is not caught with an unexpected inside quote.

Innovations in Trading Systems and Methods

Optimark

From Oct. 11, 1999, NASDAQ will begin integrate the Optimark Trading system into its existing trading network.  It is already in use at the Pacific Exchange. The Optimark Trading system is an electronic matching system for trading equities providing an anonymous and confidential trading environment with the potential for reduced costs.  

Most electronic trading systems compute size and price of a trade and search for a match with the same size and price criteria, resulting in adequate trades. OptiMark Technologies has developed a system that actually accounts for trader preference in every profile, resulting in optimal trades and improved returns for all participants. With the OptiMark Trading System, buyers and sellers are able to express their trading interests more completely than before without disclosing either their identity or the extent of their trading intent.

This is important because a trader who wishes to trade a large block will normally have to accept a lower price.  The reason is that traders trading with him do not know if his trade is informationally motivated or due to other cashflow considerations.  This situation could cause a loss of liquidity by making some traders unwilling to trade.  The OptiMark Trading System allows the trader to express his entire strategy by creating a three-dimensional "Profile" that specifies his willingness to trade at each price and size for any given equity. 

Once the trader has established and submitted a Profile that reflects his complete trading strategy, the Trading System takes his Profile and matches it with thousands of other Profiles searching for optimal contra matches at electronic speeds. To ensure a level playing field, the System first crosses an aggregation of smaller volume Profiles with larger volume Profiles, looking for the best matches. Then all Profiles are crossed and all levels of discretionary Preference are considered. Mutual Preferences for all possible contras at all price and size combinations are then ranked and allocated.  And since Profiles are matched electronically, the trader can access a large number of possible contras while his identity and trading intentions remain confidential. 

Nasdaq provides a service known as SOES that enables order entry firms and Market Makers to execute size-limited orders in Nasdaq securities on behalf of public customers. SOES enables participants, among other things, to lock in their trades with designated clearance and settlement instructions, thereby providing an automated execution system to public customers. Only agency orders from public customers no larger than the maximum order size, may be entered by a SOES order entry firm into SOES for execution against an SOES Market Maker. 

Nasdaq (Information from the NASD website) provides a service known as SelectNet that permits NASD member firms to enter buy or sell orders in Nasdaq securities into the system, directing those orders to a single Market Maker (directed orders) or broadcasting the order to market participants (broadcast orders). SelectNet facilitates the communication of trading interest between members, the negotiation of orders with the possibility of price improvement, and the dissemination of last sale reports after execution of SelectNet orders. Traditionally, SelectNet has been used by members, Market Makers, and order entry firms alike, to access the quotations of other Market Makers and electronic communication networks (ECNs). An order entered into Selectnet is like a dialogue between the trader and the market makers to reflect a bid or an offer; it is invisible and only market makers can see the order. 

An Electronic Communications Network is simply a private trading system maintained separately from the public markets such as NASDAQ and NYSE. The issues traded are the same, but the liquidity can vary. In any one instance, the inside market may be different on an ECN than on the public markets (or another ECN).  The list of ECN's is growing rapidly; here are some of the most important:

• The Island
• Archipelago
• Instinet (INCA). Instinet is maintained by Reuters, Inc.  Their terminals can be found all over Wall Street and institutional trading floors, and the participants tend to be the market makers themselves and institutional money managers.

Super Designated Order Turnaround System - Transmits member firms' market and day limit orders, up to specified sizes in virtually all listed stocks, through the common message switch to the proper trading floor workstation. Specialists receiving orders through SuperDot execute them in the trading crowd at their posts, as quickly as market interest and activity permit, and return reports to the originating firm's offices via the same electronic circuit that brought them to the floor. Super Dot can handle daily volume exceeding 2 billion shares. 

NYSE OpenBook provides a real-time view of the Exchange's limit-order book for all NYSE-traded securities. NYSE OpenBook™ lets traders see aggregate limit-order volume at every bid and offer price, thus responding to customer demand for more depth-of-market data and raising the NYSE market to an even greater level of transparency. NYSE OpenBook™ is available via an electronic data feed or via market data vendor services.

Since the switch to decimal prices, demand for market-depth information has surged. This is largely attributed to the fact that with liquidity spread out over 100 price points—instead of the 16 under the previous fractional-pricing system—traders and other market participants have found depth of market difficult to discern. 

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