Technology, Liquidity Brew a Better Trading Vehicle for Retail Investors

Alternative trading systems, long the province of institutions, are coming to the retail investor soon.
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IPOs. Equity research. After-hours trading. Online investors are getting it all.

And now, faster than you can say electronic communication networks, they may have access to trading platforms that can do much more than merely match limit orders, as several established institutional systems find their way to mom and pop. It's becoming a shotgun marriage of liquidity and technology.

Alternative trading systems -- close cousins to the ubiquitous ECNs but so far dominated by institutions -- are linking up with brokers to give individual investors access. These systems not only electronically match buy and sell orders the way ECNs do (buy 200 XYZ at 149), but they also allow investors to set more complicated parameters for investing within a set time frame (buy 100 XYZ at 150, or 200 XYZ at 149).

That means individual investors liberated by the low cost and flexibility of cybertrading and order-matching systems like ECNs may look forward to more efficient trading -- and better executions -- as alternative trading technology expands.

"I believe that ECNs really are just the beginning," says Robert Mazzarella, president of

Fidelity Brokerage

. "ECNs can generally match the customers' orders, but the more we add artificial intelligence into our order-routing and into our executions, the better the execution will be."

Gearing up for these technological developments, Fidelity recently bought a stake in the


ECN, which is flexible enough to permit new trading technologies as Fidelity's retail customers demand. RediBook was a trading tool for institutional clients of

Spear Leeds & Kellogg

up until a few months ago, when retail demand for electronic trading sent Fidelity,

Charles Schwab



Donaldson Lufkin & Jenrette


knocking on Spear Leeds' door.

The brokerages are now revamping the once-institutional electronic trading platform to take in retail order flow, aiming to improve liquidity and prices.

Demand for electronic trading systems has been driven in the past year by online trading, which has created demand for completely electronic systems for retail trades. In addition to sending orders to the market-making and specialist systems used by the


and the

New York Stock Exchange

, respectively, brokerages are also sending them to ECNs. This demand has grown so rapidly that there are now nine ECNs out there, all trying to match limit orders internally.

Having finally gotten the notice of the

Securities and Exchange Commission

, these ECNs are now being pushed to link among themselves, creating greater liquidity. In fact, the SEC is pushing for greater links among stock and options exchanges, and alternative trading systems are no exception.

"It's an easy argument that the continuous and crossing markets need to be linked in some way and that the liquidity of the one should be linked with the other," says

Bloomberg Tradebook's

Kevin Foley. (The continuous market involves traditional trading, in which buyers constantly look for sellers and sellers for buyers. Crosses take place during a set time period.)

ECNs such as RediBook were built as a way to match institutions' large block trades anonymously, but they have found a second life as technological change has swept the investing world. Now alternative trading systems are in the early stages of what looks like a similar trend.

Perhaps through links or perhaps, as Fidelity's Mazzarella says, through lookalike systems, the services of alternative trading systems such as






, the

Arizona Stock Exchange



(JEF) - Get Report


are headed into retail investors' hands.

Alternative trading system Optimark, which allows investors to specify the price and size of a trade, has already made it inside the retail world's door. This trading system has been integrated into the Nasdaq stock market system and is available to all broker-dealers and market makers who want to use it.

"The way the Optimark matching engine works is that it allows us to aggregate lots and lots of smaller orders to meet with a larger order," says Optimark Chief Executive Philip Riese. "It treats the smaller orders with the same equality as the larger orders and it can get price improvement."

Other systems are making strategic moves that could put them in the retail sector as well. Tradebook and Posit said on Oct. 13 that their agreement to build a "superECN" was dissolved because they don't want to create an exclusive link between Posit and Tradebook. Instead, Posit and Tradebook will link to additional systems, a move Foley says was driven by the need to ensure that their customers get the best price.

And the Arizona Stock Exchange and Optimark both say they are talking to other ECNs about creating their own links.

"The proliferation and fragmentation means that there is a new reason for dealers to care about getting a call market going," says the Arizona Stock Exchange's Steven Wunsch. (Unlike the ATS outfits, the Arizona Stock Exchange is a call market, or an auction in which all the orders are weighed to determine a final price for the trade.)

Wunsch says he's talking to dealers and ECNs that are looking for a way to differentiate themselves in an increasingly commoditized area, and adding a link to an auction can do that.

Still, some experts consider the need for this kind of capacity dubious because retail investors don't need anonymity to avoid moving a stock price and typically trade highly liquid stocks.

"Retail trades are so small and numerous that you can have a perfect match, and there are so many players that there is more trade volume," says Russell Keene, an analyst at

Putnam Lovell de Guardiola & Thornton

. "The ECNs are sort of a natural for that sort of volume."