Here it is. (Note to Baron: I have repost rights to my RM material)
I got dozens of e mails about the article and situation. I'm amazed how little press this is getting. This is so retro. The thing that scares me is the exchanges may succeed in getting us all back to the 1980s.
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Another Obstacle for Retail Traders
By Alan Farley
Special to TheStreet.com
09/23/2002 12:04 PM EDT
Island ECN sent shockwaves through the retail trading community Thursday night, saying it will no longer disseminate quotes on exchange-traded funds listed on the American Stock Exchange. These popular instruments, especially the Nasdaq 100 Tracking Stock (QQQ:Amex - news - commentary - research - analysis), have become a vital part of doing business for daytraders or scalpers, with many at-home players trading this security exclusively.
First, thank the long bear market for the current ETF mania. You can sell them short without an uptick, and many trade on a parallel track with futures counterparts, especially the Chicago Mercantile Exchange's E-minis. This generates arbitrage and hedging by big players, and it attracts small traders who don't have adequate funds to open futures accounts.
Island's move was prompted by a decision from Securities and Exchange Commission. The government's reasoning in suspending Island's authority to post quotes sounds reasonable at first glance. The stated aim is to maintain an orderly market that does not "cross" or "lock." This means the bid, or selling price, stays lower than the ask, or buying price, and the trader gets the best fill available at the time.
Unfortunately, the Amex specialist maintains order flow through an antiquated system that ensures delays and poor fills. In other words, it can't keep up with Island's electronic execution, or with an order book that surges past the exchange's bid-ask when volatility rises.
The real reason for the prohibition is far more sinister. The Amex is losing business to Island in a big way. Volume in the Nasdaq 100 Tracking Stock has tripled since the market top, with the issue now trading more than 100 million shares a day in many sessions.
Most of this new volume is going to Island instead of Amex because of the superior quality of its trade executions. This doesn't sit well with the old guard at the helm of the exchange specialist system.
A trader or hedge fund using Island often gets a better order fill than when routing through the exchange. Amex market orders are notorious for delayed fills at the worst possible prices. Guess who benefits when this happens? That's right, the specialist, who can work the book for a substantial profit when volume is pushed into the edges of the short-term swing.
Retail daytraders and scalpers have a right to feel unfairly targeted by the SEC and the exchanges. Last year's pattern-daytrading rule forced legions of small players out of the market because they couldn't meet the minimum cash requirements needed to establish new accounts. Was this rule designed to protect small traders from themselves? Absolutely not. Market insiders pushed for the rule because the retail crowd undermined their monopoly control of order flow.
Why is the SEC taking this action now? Island and Instinet (INET:Nasdaq - news - commentary - research - analysis) completed their merger the day after the announcement, so we can't rule out the possibility that the ECNs worked out an arrangement that ensured the merger.
Furthermore, Island was violating rules that apply to exchange-traded securities when an ECN handles 5% or more of an instrument's volume in four of the last six months. Island shattered the limit a long time ago with the Nasdaq 100 Tracking Stock, and it now averages about 40% of the daily volume in the issue. The SEC had given Island an exemption because of its value to investors and traders, but it decided to lift it.
But the real insult to the trading community comes from the irony of the situation. Retail traders remember when the big boys blamed daytrading for the market's ills while ignoring criminal acts in America's boardrooms. Now these same folks are telling us how they're reforming a corrupt system and making it more democratic for the average investor. In the meantime, they're silently undermining the reforms needed to bring trust back into the markets. Same as it ever was.
Island is attempting to reinstate its position. The fortunate thing for the trading community is that we're very resilient, and we will recover from this latest blow. And the old guard don't realize how easy it is to find new ways to make their lives miserable.
