Page 59 - THE MARKET WHISPERER

THE MARKET WHISPERER 57

Specialists hold a dual role. Firstly, they must provide reasonable
liquidity when there are no buyers or sellers for the stock, by buying and

selling to their own accounts. This prevents fluctuation during periods

when there are no other buyers or sellers. Secondly, they serve as brokers

for the brokers, by setting buy and sell orders and carrying them out at
the best price possible, known as “best execution.” For example: when a
certain broker is interested in executing a sell order for a client for a stock
priced at $50, but the client’s order is to buy at $49 in the hope that the
stock will drop to this level, the specialist keeps the order on his or her

book, called “booking the order,” and executes it when the price reaches

the client’s preference. The law requires that specialists must respect the
client’s interests over their own at all times. Until just a few years ago, prior
to computerization, every buy and sell order went through a specialist.
Currently, most NYSE executions take place via automated trading, similar
to the NASDAQ format.

The ECN Revolution

The role of market makers and specialists is important, but it’s not as
though they work for free. The fact is that they make their profits from the
spread between the bid and ask, which means that we pay their price.

An ECN (Electronic Communication Network) allows us to forego their
intermediate services. The ECN is a network of computers that allows
buyers and sellers to connect and set buy and sell orders without the
“mediation” of market makers. ECNs began operations in 1969 with the
very first system known as “Instinet,” which initially was used only by the
market makers for transactions between one another.

Due to the lack of liquidity that led to the 1987 collapse, laws were
passed forcing market makers to respect electronic orders. These laws
saw the first usage of ECN systems by the public. Currently, the majority of
orders we execute are placed through ECNs.

Stock traders, in contrast to investors, use “Direct Access” trading
programs, which we’ll study later on. Through direct access programs,
we can choose to send buy or sell orders directly to market makers, or to
the range of ECN systems. Another popular option is to use the services
of a broker who will automatically choose the most suitable direct access
channel for you in terms of execution speed and cost.