FOURTH MARKETS

Crystal Cady • BA543 Spring 2013

Brief Introduction to ECN’s Off-exchange trading in the market

Computerized system that allows traders to bypass major stock exchanges, brokers & trading floors

Primary products traded are stocks and currencies Considered ‘fourth market’

Relatively new phenomenon for individual traders Until recently were only used by financial institutions

and market makers

Sanctioned by the SEC Played a key role in growth of ECN’s

Why ECN’s? An alternative to the conventional equity trading

arrangements

ECN’s were created to bypass the other exchanges and trade directly with one another Access to favorable pricing Ability to trade after-hours

Designed to be a trading system for institutional investors Allows traders to meet in an anonymous market Allows for trades all over the world regardless of physical location

History of ECN’s Began operating in 1969

Instinet was the first ECN Operated similar to broker-dealer for nearly 30

years SEC imposed order handling rules in 1997

Created a new category that applied to Instinet (ECN)

Allowed for individual (retail) trading in addition to institutional

Negative effect on NASDAQ Number of ECN’s rose significantly Resulted in major loss of volume in under two years

History of ECN’s New entrants in the 90’s took on retail flow By 2000 nearly a dozen ECN’s existed

Archipelago bought Pacific Stock Exchange to become the first fully electronic stock exchange

Consolidations reduced the number down to a few

Once only larger players remained several applied to SEC to become an exchange Allowed for faster, more direct transactions

Today’s Major ECN Players Bloomberg Tradebook LavaFlow

A division of CitiBank ArcaEdge

Merger of Redibook and Archipelago

How ECN’s Work Two main types: Retail & Institutional Pass on prices from multiple market

participants Display the best bid/ask quotes on

platforms ECN- brokers also serve as

counterparties to forex transactions What is a forex transaction?

Make money by charging customers a fixed commission for each transaction

How ECN’s Work

Pro’s of ECN’s Achieve better bid/ask prices Can trade on prices with little or no spread

Why is this important? Genuine ECN brokers will not trade against

you Prices may be more volatile

Better for scalping purposes Can take on role of market maker

Con’s of ECN’s Many don’t offer integrated charting &

news feeds Trading platforms tend to be less user

friendly Difficult to calculate stop-loss and

breakeven points in advance Traders have to pay commissions per

each transaction

TIP: Get yourself a good broker!

QUESTIONS?