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Bacteria and Stock Exchanges

28

July, 2010

Last week we had a little history lesson on electronic trading.  Today, we wish to give a quick science lesson.  Who knows what Binary Fission is?  Binary fission is the most common method of reproduction in bacteria. It is a process in which a parent cell divides to produce two equal-sized daughter cells.   The daughter cells then separate from each other and become independent. The repeating of the process results in exponential multiplication of the bacterial population.

We bring up this science lesson because as of July 12th, a new venue, the NYSE Amex, has just started trading NASDAQ stocks.  The NYSE Amex model of parity and priority will be in effect for NASDAQ stocks (http://www.nyse.com/pdfs/fact_sheet_nasdaq_utp.pdf).  As the NYSE Amex release states: “The parity-based system enables the DMM, any floor broker and the first order in the exchange’s order book to have equal standing in terms of execution priority at a particular price level.”  This should make for some new and very interesting HFT strategies.

While we have now 4 major equity exchanges in the US, each one has been undergoing a “binary fission” process.  The NYSE now has NYSE “classic”, NYSE ARCA and NYSE Amex.  NASDAQ has NASDAQ OMX, NASDAQ BX and is pending the launch of NASDAQ PSX.  Direct Edge has EDGA and EDGX.  BATS has its current BZX and is pending approval of the new BYX.  So, our 4 US exchanges are really 10 destinations.  When you add the smaller exchanges like NSX and CHX, and then throw in a few  ECN’s, like FLOW, we see how the number  of  ”lit” destinations  keep multiplying like bacteria,  and fragmenting the market. Lets not even get into the more than 40 dark pools.  Why are the exchanges doing this?  If you ask them, they will likely say to give the customer choice. We think that they are all trying to create new hyper-trading arbitrage opportunities, needs of investors be damned. This also creates an ever increasing need to co-locate at the highest levels, buy increasingly expensive direct feeds, as well as a need to keep buying new Cisco servers. We alsothink a quote by an industry consultant, Sang Lee, sums it up best:  “It’s a hypercompetitive environment…You’re literally gouging each other’s eyes out for a sort of single-digit market share.”

With that type of loss of perspective and “eat what you kill” attitude, it’s no wonder that investor confidence is at all time lows.

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