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Book Review of Broken Markets
Many people were introduced to the stock market during the bubble of the late 1990’s. With the development of online trading companies, such as E*Trade and Ameritrade the stock market opened to the individual day trader. Thousands of transactions occurred through electronic exchanges causing trading volume to increase and broker’s fees to decrease.
Over the past 15 years super fast computers and automatic computer algorithmic trading programs have restructured dynamics of stock markets. A new book Broken Markets by Sal Arnuk and Joseph Saluzzi describes how High Frequency Trading companies control the market place. The authors have two decades of stock market trading experience and are seasoned institutional traders. They have written many articles about the stock market and high frequency trading and translate their expertise into a textbook narrative that the layman can understand.
The authors explain that up until the last few years United States stock markets were a duopoly of the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotation system (NASDAQ). The New York Stock Exchange was a non-profit market were broker dealer investment banker companies paid for a place on the exchange. These companies brought companies public and traded for their investors. There were specialists and market makers that kept the flow of trades in balance. The NASDAQ was the first electronic exchange that brought small company startups to the market place. The authors give an example of Intel’s IPO on the NASDAQ in 1971 for only $6.8 million. These markets helped raise capital for companies and made money for investors.
Today’s markets are for profit exchanges. The stock exchanges make money from trading volume. All trading is done electronically and market makers and specialists are relics. The volume listed on the NYSE and NASDAQ is only 25% of the total volume traded on the other electronic exchanges including dark pools. Dark Pools are exchanges not available to the public. High Frequency Trading (HFT’s) companies control the stock market. They take large trading share blocks and break them down to 100 to 500 shares per trade. The HFT’s front run the bid and asks shown to the public. They may shave a penny per share on these trades. These trades are executed in fractions of a second. The HFT companies make millions of dollars. They game the system by trading back and forth and not holding any shares of stock at the end of the day. These companies are not market makers. On the old NYSE market markers would hold, buy and sell shares of stock in order to keep shares available for the retail investing public. This helped prevent a stock from crashing. Today’s HFT companies dump shares of stock as quickly as possible when it is to their advantage. Thus you get a FLASH CRASH that occurred on May 6, 2010, that cost investors millions of dollars. The author’s Saluzzi and Arnuk also warned that the IPO for Facebook would have problems because of the mechanisms in the electronic markets.
I highly recommend Broken Markets to anyone interested in how the modern markets work. Maybe the old stock exchange outcry method was a better way of doing business. In the movie Wall Street, it sure looked like the traders, specialists and market makers on the NYSE were having a lot of fun. These broker dealer investment bankers helped new companies raise capital, grow, hire new workers and make money for investors.