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The Wall Street establishment calls them bandits.
To ordinary investors they look more like Robin
Hoods. Meet the guerrilla marketmakers who are
helping squeeze down the cost of Nasdaq trading.
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Great article, will bring more money into the market for us.
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
Free enterprise comes to
Wall Street
By Matthew Schifrin with Scott McCormack
IT'S JUST DOWN THE
BLOCK from the New York
Stock Exchange, at 50 Broad
Street, but not nearly so grand.
Take the elevator to the second
floor and walk through a sparsely
furnished office suite and you come to a dimly lit,
makeshift trading room. There, from 9:30 a.m. to
4 p.m. each weekday, sit 50 people all males
eyes firmly attached to monitors. The players are
mostly under 30, wearing T shirts, blue jeans and
baseball caps. They talk to one another even as
they pound on the keyboards. More often they
just stare intently or blurt insults at the screens.
A videogame arcade? You could easily mistake it
for one. In fact, a lot of money is changing hands
in this guerrilla trading room where smart
freelancers are competing against giant
over-the-counter marketmakers like Merrill
Lynch, Goldman, Sachs, Morgan Stanley, Knight
Securities. These traders hope to get rich by
shaving small slices off marketmaker spreads in
o-t-c stocks like Dell, Amazon.com, Excite,
Yahoo!, Intel and Microsoft.
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>.
Sorry, NO HOPING ALLOWED.
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
Thanks to market reforms inspired in part by
FORBES' exposés of excessive spreads in o-t-c
markets (Aug.16, 1993; July 29, 1996)--these
young, guerrilla marketmakers are often able to
dance around the big players. Helped by fast,
relatively inexpensive technology, they pick off
eighths, sixteenths, thirty-seconds and even
sixty-fourths of a point per share, but on
tremendous volume. By the closing bell, most
have sold out of all their positions, ready to do
battle again in the morning.
The young men in this room are only a fraction of
the guerrilla marketmakers currently on the prowl.
They are customers of a small brokerage firm,
Broadway Trading. This outfit provides them with
the hardware and software to make markets and
charges them 2 cents a share in commissions on
their trades. An affiliate trains them to day-trade
for a $1,200 upfront fee.
Other than that, the traders are on their own,
playing with their own money. Last year
Broadway's 300 customers, many trading from
remote locations, accounted for more than 1
billion shares in Nasdaq trading volume—0.7% of
its total.
The establishment sneered at
SOES bandits. Robin Hoods
might be a better description,
though the day-traders' motives
were no more pure than the big
brokers'.
Other guerrilla marketmakers there are about
2,000 of them in all probably account for another
12% of Nasdaq volume. But it is not just the
competition that irks the big brokerage houses.
With their low overhead, the guerrilla
marketmakers have helped narrow the fat trading
spreads Nasdaq marketmakers have long
wallowed in.
For years, this is what happened if you wanted to
buy or sell a Nasdaq stock: Your buy order went
to a marketmaking firm, which charged you the
offer side of the market, pocketing the difference
between that price and the lower bid. This
difference is the spread. The marketmakers rarely
allowed customers to trade inside the spread,
even if one customer was willing to pay the same
price that another customer wanted to sell his
stock for.
It wasn't exactly a monopoly. It was more, shall
we say, a closed game. The Securities &
Exchange Commission finally pried the game
open and let in people like Serge Milman. This
crew-cut 25-year-old from Saint Petersburg,
Russia is out to make a buck, but he and people
like him are saving investors tens, possibly
hundreds, of millions of dollars a year.
Milman traded 30 million shares of stock last year
and grossed about $1.4 million. After paying
commissions to Broadway, Milman claims to
have taken home $800,000 before taxes.
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>.
Good for him. How many guy's went broke?
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
Milman makes about 150 trades each day, mostly
in lots of 1,000 shares or fewer, and rarely holds
a stock more than ten minutes. To Serge Milman
it's just a numbers game. He doesn't know or
care what any of the companies do. He doesn't
read the Wall Street Journal or any other
investment publications, nor does he do any
research.
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He is a GRINDER.
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Watch him in action. With the stroke of a key
Serge buys 1,000 shares of ALCD. "What's that
stock?" asks a visitor. "I have no idea, dude. It
has a big spread, and it's moving. I like to get
inside the market on those kinds of stocks," he
says. A few minutes later he is out of ALCD, a
hot biotech company, with a couple of thousand
dollars in profit.
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
ALCD Traded 7,100 shares today. 22 total trades.
Looks like a sucker stock to me.
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
In mid-March XCIT, the stock symbol for
Internet search-engine company Excite, opened
at around $50 per share. After a few minutes of
trading it pulled back so that its bid was 49 3/8
and its offer was 49 3/4, a 3/8 spread.
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>.
Anybody out there trading a 3/8 spread?
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
A spread like that is pure gold for people like
Milman. Using software that links him directly to
Nasdaq marketmakers and a private trading
system called Island, Milman checked further. He
discovered that there were three marketmakers
on XCIT's bid and two on the offer. He figured
XCIT would rebound. Taking advantage of the
wide spread between bid and offer, he bid 49
7/16 for 1,000 sharesa 16th over the best
marketmaker bid. (A 16th in marketmaker
parlance is a "teenie.")
In the past Milman's bid would not have
appeared on the Nasdaq screens because official
Nasdaq marketmakers posted bids at their
discretion. Before the new SEC-mandated rules,
marketmakers would often let limit orders pile up
unexecuted unless the market rose or dropped to
a point where they could get their accustomed
spread. In the end the SEC decreed, in August
1996, that marketmakers were colluding and
gouging the public. In December 1997
marketmakers agreed to pay $1 billion to settle a
class action that investors brought. Equally
important, the gates of Nasdaq were thrown wide
open.
The most important provisions of the rules force
marketmakers to fill or broadcast a customer's
limit orders to all other marketmakers on the
Nasdaq system if it improves on the inside price.
It also let private trading systems called ECNs
(electronic communications networks) post their
prices on the same system. No more can dealers
sit on an order until it pays them their spread.
Back to Serge Milman and his XCIT. Having
topped the marketmakers' bid, Milman got first in
line to execute an order at market. The first 1,000
shares for sale at market went to him at 49 7/16.
Almost immediately he offered to sell for
491116still lower than the asked price posted by
the big marketmakers. Milman guessed right, and
the stock was taken off his hands in just 12
seconds. In a few strokes of the keyboard he
netted $210 and cut the spread by 1/8 of a point.
Multiply that by hundreds of trades per day and
thousands of day-traders around the country and
you can see why trading spreads are narrowing
and why the big marketmakers with their high
overhead complain that they can't make money in
the traditional way.
So profitable was the over-the-counter business
that big marketmakers like Herzog, Heine,
Geduld; Troster Singer; and Charles Schwab's
Mayer & Schweitzer paid retail brokers to send
them their "order flow," that is, the right to
execute their Nasdaq orders. They still sell order
flow, but the price for order flow has dropped by
more than 50% in the last year. It could fall
further.
The big winners, of course, are
investorsprofessional and individualwho now can
buy or sell Nasdaq stocks at far more reasonable
transaction costs. The National Association of
Securities Dealers says spreads on Nasdaq
stocks are down 30% in the past year. If the
figure is correct, that squeeze saves investors
some $20 billion a year.
Freelancers like Serge Milman require nothing
more than a quick brain and some money. For
what they need to trade, they go to places like
Broadway Trading. Broadway was founded just
last year by Marc Friedfertig and George West,
formerly American Stock Exchange options
traders. "I made markets in dozens of Wells
Fargo options contracts, but the costs and the
risks I faced began to outweigh the rewards,"
says Friedfertig.
Other Wall Streeters have heeded the call. Sitting
next to Serge Milman in Broadway's trading room
is Steven Girden, 36, a former o-t-c
marketmaker at Bear, Stearns' risk arbitrage
desk. "Big marketmakers have always had an
edge in terms of order information. But with our
new trading software, the playing field has
become level."
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
The playing field has always been level.
YOU just have to know how to trade.
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
Broadway and other firms use ECNs similar to
but on a smaller scale than Reuters' Instinet. They
are basically electronic limit order books that
match buyers and sellers without any middleman.
One of the fastest-growing networks is Island. It
was formed in the mid-1990s by a couple of guys
who never made it through college, Jeffrey Citron
and Joshua Levine. Like a lot of the other guerrilla
marketmakers, Citron and Levine got their start
through Nasdaq's Small Order Execution System,
or SOES. An early response to critics of
Nasdaq's voluntary dealer market, SOES
allowed orders of 1,000 shares or fewer to be
executed automatically at marketmakers'
advertised quotes. The idea was to give small
investors a break. Few small investors knew
about it or took advantage of it, but it gave rise to
a cadre of day- traders who sought to exploit the
new system. As long as they dealt in lots of 1,000
shares or fewer, they could use the system and
get their orders executed instantly. People like
Milman became what the establishment sneered
at as SOES bandits, blaming them for
unnecessary volatility. Robin Hoods might be a
better description, though the day-traders'
motives were no more pure than the big brokers'.
Island cofounder Citron was a trader for a SOES
firm that has evolved into the currently hot
Internet Web brokerage Datek Online. His
partner, Levine, started as a runner, but soon
began writing software programs. Over the years
Levine figured out how to efficiently access and
interface with Nasdaq's SOES and SelectNet
system.
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>
Programmers make a lot of money.
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Citron and Levine saw
marketmakers weren't matching
orders that didn't give them their
spread. Match trades privately?
They found there were no rules
preventing this.
Pooling their complementary skills, Levine and
Citron developed a series of DOS-based
programs that made monitoring stocks and
trading easier and faster. On a single screen the
system allows traders to monitor the market, their
current positions and other indicators. It also lets
them view marketmaker quotes in any three
stocks at a time and to execute transactions in any
of the three.
These were very smart boys. They soon noticed a
quirk in the Nasdaq software: If they were to
place a SOES bid that said "I'll buy at the offer or
up to 20% over it," their order would
automatically take precedence over all other
market orders and would give them an advantage
in a rising market. Levine created a program that
with a stroke of a key would create such an
order.
When Levine and Citron tried to sell their trading
software, called the Watcher, to The Street, the
big houses would have none of it. Perhaps they
hoped the whole spread-cutting business would
just go away. But day-traders ate it up.
Citron and Levine also noted that marketmakers
were failing to match buy and sell orders that
didn't give them their accustomed spread. Say
there was an offer to buy 1,000 shares of Intel at
$75, and another order to sell it at $75. Nothing
would happen because crossing the order would
create only a commission but no spread. Most
times the orders would go unexecuted.
Why not match the trades in a private transaction
system? The pair checked NASD regulations and
discovered that there were no rules preventing
this, so they created software and a network of
personal computers that would simulate a giant
electronic limit order book.
Levine and Citron dubbed their new private
trading system Island. The name symbolized that
they operated outside of Nasdaq but had a bridge
to it. Here is how Island works:
When a broker or trader who uses Island places
a buy order, it is routed first to Island to check for
matches. If there are none, the order is posted
electronically in the Nasdaq marketplace by
Island. If a matching order comes into Island at
the same price a few seconds later, say, the
forwarded order is matched with the new order
on Island.
Island offers not only lower cost but speed of
operation. Charging only $1 per transaction
regardless of size, Island is cheaper than
Nasdaq's SelectNet or Instinet. Island is a key
factor in the success of fast-growing Internet
brokerage Datek Online. Datek has more than $1
billion in customer assets and a slogan that
promises that if it doesn't execute your market
order within 60 seconds, you don't have to pay
the $9.99 commission.
With day-traders thriving and Datek taking off,
Island's volume has swelled to 34 million shares
per day recently. Already Island accounts for
more than 4% of Nasdaq share volume. In
February a full 56% of Island's executions were
matched in-house—meaning Nasdaq was not
involved at all.
There are now at least four other new electronic
communications networks (see chart), including a
fast-growing ECN from Bloomberg called
Bloomberg Tradebook and one from
marketmaker firm Spear, Leeds & Kellogg.
More are on the way.
So Adam Smith is alive and well on Wall Street.
According to a study done at Rutgers University,
these networks were 1.7 times as likely to quote
increments such as 1/16, 3/16 or 11/16 than
marketmakerswho more often traded in
increments of 1/8 or 1/4.
FORBES checked to see how responsive the
ECNs were at posting limit orders. One recent
afternoon we telephoned marketmaker Herzog,
Heine, Geduld with an inside bid. Four minutes
passedfor two of them we were on holdbefore
our bid for 100 shares appeared on a Nasdaq
marketmaker screen.
We next tried Web broker E*Trade: It took
E*Trade two minutes also, then our limit order
was posted by Bloomberg Tradebook.
We next tried Datek Online, which uses Island to
post limit orders. From the time we gave the
order, just three seconds passed before it hit the
Nasdaq screen.
In their personalities and demeanor as well as in
their business techniques, Levine and Citron are a
challenge to the Wall Street establishment. Check
out Island's Web site at www.josh.com. It shows
Levine, 30, and Datek Online's chief technology
officer, Peter Stern, also 30, lounging in jeans and
T shirts. The Web site provides real-time access
to Island's limit-order book in any Nasdaq
stocksomething most other marketmakers guard
with their lives. Levine's lower Manhattan office
suite is home to an 18-inch lizard, three turtles
and an authentic bazooka.
Guerrilla marketmaking has been good to these
boys. In 1996, for example, day-trading firm
Datek Securities paid Citron and Levine almost
$145 million for using software and services like
Island and the Watcher. Citron, 27, has a
Gulfstream II-B, and, as the new chief executive
of Datek Online, has moved headquarters and
duplicative backup systems for Island to Iselin,
N.J. He also paid $3.3 million for the baronial
former home of stock manipulator Robert
Brennana name familiar to longtime FORBES
readers. Once in possession, he called in a
bulldozer and demolished the residence to make
room for a new 20,000-square-foot palace.
So far Island has about 200 broker-dealer
subscribers, including Datek Online, and
day-trading firms. Understandably the big
brokerage firms want no part of it: Though
spreads have narrowed on their over-the-counter
business, that payment for order flow, though
diminished, is still substantial. But maybe not for
long.
The private trading systems aren't going away.
"We would like to trade NYSE stocks," says
Levine.
Are do-it-yourself marketmakers helping or
hurting the small investor? Tell us at On-Line
Pulse at www.forbes.com.
>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>.
They are good for the economy.
The more money that comes to the market is more money that smart
money will take.
A TRADER TRADES AGAINST HIMSELF.
Bob
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Sidebar: An M.B.A. in videogaming
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Read more:
By Matthew Schifrin
On The Cover
From April 6, 1998 Issue
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