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Fourth Markets

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

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Fourth Markets

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  1. Fourth Markets Crystal Cady • BA543 Spring 2013

  2. 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

  3. 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

  4. 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

  5. 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

  6. Today’s Major ECN Players • Bloomberg Tradebook • LavaFlow • A division of CitiBank • ArcaEdge • Merger of Redibook and Archipelago

  7. 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

  8. How ECN’s Work

  9. 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

  10. 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!

  11. Questions?

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