How Did We Get Where We Are Today? A Suspect Emerges.

May 1, 2014 2:28 PM
By Ted Oberhaus

In this second of a series on high-frequency trading, Ted Oberhaus looks at Securities and Exchange Commission [SEC] Regulation National Market System (Reg. NMS), enacted in 2005 and fully implemented in 2007.

A Trader's Perspective

Remember the good old days when you could practically count the number of U.S. stock exchanges on one hand? There was the NASDAQ, the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), and the Chicago Stock Exchange (CSE). Today, the AMEX has been merged out of existence; the wood paneling of the CSE’s trading floor has been curated to the Art Institute of Chicago; and the NASDAQ and the NYSE are filling only a fraction of the U.S. stock orders they used to.

Instead of four major U.S. stock exchanges, we now have 13 as well as somewhere between 40– 50 so-called “dark pools,” or off-market platforms for trading, the latter category of which accounted for 40.7% of all stocks traded in January 2014, according to The Wall Street Journal.

The SEC’s goal with Reg. NMS was to foster competition, use electronic trading systems to link markets together and provide more transparency, and lower trading costs for retail investors—all of them honorable objectives.  And we want them to succeed.  But what attended Reg. NMS was the law of unintended consequences.   

Some consider the “flash crash” of May 2010, when a big sell order filled by computers unleashed a massive sell-off, as the moment of most consequence. It was the real test of the new market structure that Reg. NMS had unintentionally fostered: a highly fragmented marketplace populated by high-frequency traders who, unlike the specialists of yore, had no obligations to support the market when things spun out of control. 

From a trader’s perspective, and certainly from the perspective of an investor, market competition is a good thing because it can lower costs. And there is evidence that Reg. NMS and other rules have reduced transactions costs, lowered commissions, and tightened spreads for investors. But the byzantine complexity of the current market structure is creating chaos, and the role that high-frequency trading has played in abetting that chaos needs a re-examination. Having identified Reg. NMS as one of the problems, we owe it to our investors to be part of the conversation that can offer solutions. And we will do so in future blogs. We invite you to join in the conversation by providing your comments below. (Recommended reading: “SEC Reg. NMS: A Long Overdue Cost/Benefit Analysis Begins.”) 

Ted Oberhaus is a Lord Abbett Partner and Director of Equity Trading.

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