Fast-forward nearly 150 years to the third week of April, 2005: Stock trading took another giant leap forward with the NYSE announcing a surprise merger with 8-year-old computerized trading platform Archipelago (AX
). Just two days later, the rival Nasdaq stock market (NDAQ
) announced plans to acquire another independent electronic exchange, Instinet (INGP
For individual investors, the new and increasingly cutthroat competition between the two major exchanges -- as well as with newer electronic trading platforms and foreign exchanges -- is likely to be a positive as trading becomes cheaper, easier, fairer, and less subject to manipulation. But traders warn that these changes, as well as recent efforts to regulate the new, far more technologically advanced trading systems, will have many consequences for the $230 billion securities business, most of them unforeseen.
"THE LAST BASTION." Given the complexity of markets, "You make one small change and then down the line as a third effect, something really bad happens," says Larry Leibowitz, who manages automated trading and broker services for UBS. And resistance to change can also play a role. Shortly after the NYSE's deal for Archipelago was announced, a group of Big Board insiders was said to be considering an offer to buy the exchange and stymie its effort to take over Archipelago.
What's at stake is nothing less than who'll be the eBay (EBAY
) of stock trading. With the major exchanges' recently announced deals, stock trading is likely to soon go all-electronic. The NYSE has carefully nurtured its system of human floor brokers and trading specialists over the past three decades as computerized trading and electronic networks took hold, offering lower costs, far faster speeds and (most traders say) better execution quality. "The New York Stock Exchange was the last bastion of doing it the old-fashioned way," says Asiff Hirji, chief information officer of Ameritrade (AMTD
). He calls the change, "decades overdue."
The NYSE still promises to maintain the historic specialist system as part of an as yet amorphous plan to create a hybrid market where some trades will be conducted electronically and some on its much-storied floor. But investors and analysts expect much of the volume to quickly migrate to improved and cheaper electronic channels once they become available. "The specialist system is a dying business," says Michael Panzner, head trader at Rabo Securities.
AVAILABLE TO ALL. None of this, however, explains Nasdaq's deal with Instinet. After all, the Nasdaq was created as the first all-electronic stock market in 1971. The explanation: Technology is also fostering a more fundamental change in market structure that even Nasdaq must catch up with: Where a trade is executed has less and less to do with where a stock is listed.
This is a bigger change than first meets the eye. In the old days -- namely, the first 200 years of stock trading -- an investor would initiate a trade by calling a broker. That broker would call a trader, who would work the order with a specialist on the floor of the NYSE or, later, electronically with a Nasdaq market maker.
In the last eight years, however, alternative trading platforms like Instinet or Archipelago have flourished thanks mainly to new regulations that required all orders to be displayed electronically to traders and made available to investors. Now a professional trader can choose the best price and strategy available from a variety of electronic platforms offered by independents, major brokerages, or a variety of exchanges.ONE UBER-EXCHANGE? For the most part, NYSE-listed stocks are still traded on the New York Stock Exchange, while Nasdaq-listed stocks are more frequently traded on alternative exchanges. But with Instinet's trading platform, Nasdaq will be able to trade many more NYSE-listed stocks. And with Achipelago, the Big Board will be able to trade Nasdaq stocks. "What we're seeing fundamentally is that the electronic order book as we know it is now becoming an integral part of the offerings of the exchanges," says Jos Schmitt, a partner and financial services consulting firm Capco.
These mergers pit the two exchanges, which have always competed for listings, in a head-to-head battle for transaction services as well. As Nasdaq Chief Executive Bob Greifeld explained in an Apr. 22 press conference, the markets had evolved to the point where, "it makes sense for competitors to trade all equities." Some electronic brokerages, such as Automated Trading Desk, are looking forward to dealing with a friendlier NYSE. "Suddenly, it will be nice to go in and deal with people who want my business," says Steve Swanson, ATD's president.
Ultimately, it makes sense for one electronic exchange to dominate in the U.S. since traders gravitate to markets where the most shares trade. But wondering whether it will be the NYSE or Nasdaq that ultimately earns eBay-like status could be like wondering whether Christie's or Sotheby's (BID
) would be the online auction leader circa 1997. Just as the revolution in electronic trading pits Nasdaq and the NYSE against each other, it also opens up room for new entrants to make inroads with improved technology.
"PLAYING IN THE SAME POOLS." And just as eBay came out of nowhere to take the auction market by storm, technology could allow a whole new player to emerge and unseat the exchanges. It has already happened in the options market where the International Securities Exchange (ISE
), which launched the first fully automated options exchange in June, 2000, already trades more volume in equity options than any other exchange. "It shows you what can happen if you leverage electronic trading tools in the right way," says Capco's Schmitt.
Brokerages also increasingly use proprietary trading services to match orders directly for institutional clients, putting them in competition with exchanges on some trades. International exchanges are another source of competition that will become more important in the increasingly connected trading world. "Interestingly, everyone is playing in same pools of liquidity," says Will Clemens, a vice-president for financial software maker Advent (ADVS
A new communications standard known as FIX (for financial information exchange) is allowing a lot more integration between institutional brokers and investment managers. "Going to an exchange will be one way to work an order, but depending on your requirements, there may be a much better way to do it," Clemens says.
EVER MORE SOPHISTICATED. For tech companies, these trading advances mean a bigger market for selling software and hardware to financial-services firms. Traders are rushing to develop ever more advanced "black box" or "algorithmic" trading programs to stay competitive. Derivatives trading will become more common and frequent as the NYSE pushes into this arena, enabled by its planned Archipelago acquisition. The booming hedge-fund industry will create even more demand for new innovative strategies using ever more sophisticated technology tools.
And discount brokerages, such as Ameritrade, plan on bringing those tools to individual investors so they, too, can essentially pick a strategy and have the system execute it for them automatically. "Technology has to continue to take the complexity out of trading," says Asiff. "That's where we'll see big changes."
Clearly high tech will play a major role in the future of investing, no matter which exchange -- the NYSE, Nasdaq, or a new company altogether -- ultimately becomes the eBay of stock trading. By Amey Stone in New York