Financial Markets and Institutions (2-downloads)

bid price (the price they pay for stocks) and ask price (the price they sell the stocks

for). They also receive commissions on trades.

Although NASDAQ, the NYSE, and the other exchanges are heavily regulated,

they are still public for-profit businesses. They have shareholders, directors, and offi-

cers who are interested in market share and generating profits. This means that the

NYSE is vigorously competing with NASDAQ for the high-volume stocks that gen-

erate the big fees. For example, the NYSE has been trying to entice Microsoft to leave

the NASDAQ and list with them for many years.

Electronic Communications Networks (ECNs)

ECNs have been challenging both

NASDAQ and the organized exchanges for business in recent years. An ECN is an

electronic network that brings together major brokerages and traders so that they

can trade between themselves and bypass the middleman. ECNs have a number of

advantages that have led to their rapid growth.

• Transparency: All unfilled orders are available for review by ECN traders.

This provides valuable information about supply and demand that traders can

use to set their strategy. Although some exchanges make this information

available, it is not always as current or complete as what the ECN provides.

• Cost reduction: Because the middleman and the commission is cut out of

the deal, transaction costs can be lower for trades executed over an ECN.

The spread is usually reduced and sometimes eliminated.

• Faster execution: Since ECNs are fully automated, trades are matched and

confirmed faster than can be done when there is human involvement. For

many traders this is not of great significance, but for those trying to trade

on small price fluctuations, this is critical.

• After-hours trading: Prior to the advent of ECNs only institutional traders

had access to trading securities after the exchanges had closed for the day.

Many news reports and information become available after the major

exchanges have closed, and small investors were locked out of trading on

this data. Since ECNs never close, trading can continue around the clock.

Along with the advantages of ECNs there are disadvantages. The primary one

is that they work well only for stocks with substantial volume. Since ECNs require

there to be a seller to match against each buyer and vice versa, thinly traded stocks

may go long intervals without trading. One of the largest ECNs is Instinet. It is mainly

for institutional traders. Instinet also owns Island, which is for active individual trades.

The major exchanges are fighting the ECNs by expanding their own automatic

trading systems. For example, the NYSE recently announced changes to its own

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Chapter 13 The Stock Market

307

Direct+ order routing system and merged with Archipelago to give it an established

place in this market. Although the NYSE still dominates the American stock market in

terms of share and dollar volume, its live auction format may not survive technolog-

ical challenges for many more years.

Exchange Traded Funds (ETFs)

Exchange traded funds (ETFs) have become the

latest market innovation to capture investor interest. They were first introduced in

1990 and by 2007 over 400 separate ETFs were being traded. In their simplest form,

ETFs are formed when a basket of securities is purchased and a stock is created

based on this basket that is traded on an exchange. The makeup and structure are

continuing to evolve, but ETFs share the following features:

1. They are listed and traded as individual stocks on a stock exchange. Currently,

all available offerings are traded on the American Stock Exchange.