SelectNet, and ECN. Each system has its own advantages, and you
should become familiar with (and have access to) all three. You will find
times when one particular execution system works better than another.
SOES.
SOES stands for Small Order Execution System. The SOES system
enables the trader to execute an order on the bid or offer of a particular
market maker (Level II). This procedure is done through an electronic
direct-access brokerage firm. The individual investor will receive software
from his or her brokerage firm or access his or her account through the
brokerage Web site, where he or she is able to place the order.
The SOES order provides for the automatic execution of your order.
This system is also known as auto-execution. When using the SOES system,
you can get your order instantaneously filled. This system is available
to the non-professional trading public only: To limit the ability of
professional traders to take advantage of price discrepancies, registered
NASDAQ broker-dealers cannot use the system.
Here are some characteristics of SOES:
1. Auto-execution up to a specific number of shares, depending on the
liquidity of a particular stock (with a 1,000 share maximum)
2. A five-minute time interval restriction between orders in the same
stock. This rule is in place to protect the market maker from investors
who might take advantage of the rapid execution.
3. Short sales require a plus tick in the stock. This rule is to reduce selling
pressure in a declining market and is applied to all stocks in an
effort to protect the market in a crash scenario.
4. The market maker is required to buy or sell shares of a stock issue
in which he or she is making a market and trade at least the amount
being posted in large, capitalized stocks.
Here are some advantages and disadvantages:
1. The advantage of SOES to the individual investor is the rapid execution
of the trade. This method is the fastest method of trading a
NASDAQ stock with a guaranteed fill.
2. The disadvantage is the limited number of shares per execution and
the five-minute interval between transactions.
3. The rules and characteristics ofthe SOES system change frequently:
Contact your broker to find out whether any rules or characteristics
of the system have changed before you trade any orders via the
SOES system.
SelectNet.
SelectNet serves as a means for the rapid routing of orders
to market makers. This system has replaced the telephone-which, prior
to the development of SelectNet, was the only means by which to trade
with market makers. SelectNet enables a trader to send a bid or offer over
NASDAQ directly to a market maker who is making the market in a particular
issue. The market maker then decides to trade all or any part of
your order. You can choose to send the order to all market makers who are
making a market on a particular issue, or you can "preference" a selected
market maker. Traders might want to select a particular market maker
who they feel honors the markets in which they are disseminating (and/or
returns filled information promptly).
Here are some advantages and disadvantages to this system:
1. The advantage of SelectNet to the individual investor is that it enables
him or her to choose which market maker with which he or she
wishes to trade. This method is also faster than calling your broker,
who would have to either SelectNet for you or call market makers
directly in order to fill your order.
2. There are, however, three shortcomings to using SelectNet. First,
market makers are not obligated to trade with you if they can show
that they have already traded at that price. Second, SelectNet does
not offer any limit order protection. If you place a SelectNet order
and select a certain market maker, the stock could be trading elsewhere
at your limit price-and you would not be guaranteed a fill.
Lastly, SelectNet orders are not disseminated. SelectNet only displays
your order to the market maker(s) whom you have referenced.
Someone out there might be willing to buy or sell the stock to you for
your price, but if you have not selected to show him or her the offer,
then he or she will never know that your offer was available.
ECN.
ECNs are not stock exchanges; rather, they are proprietary net-
work systems that enable investors to trade OTC stocks. All ECNs are
open to retail investors so that they can trade any OTC stock, and some
enable investors to trade listed stocks. There are currently 10 ECNs,
~ although as the demand grows, more ECNs will be formed. Note that
some ECNs enable 24-hour trading, while others are only open during
market hours.
ECNs represent an auction-based marketplace that enables individual
investors to place orders that are available to everyone who is currently
watching the particular ECN. An ECN can list many bids and
offers on any particular stock. Each stock that is trading on an ECN has
its own auctionary online room where all of the bids and offers are displayed.
Although the ECN market might not reflect the same market on
Level II, it directly competes with Level II. An ECN system might have
the best market at any particular time, making the ECNs a viable alternative
place in which to trade stock. You can see most ECN systems ifyou
are watching Level II.
Examples of ECN systems are Instinet, Island, Archipelago, and
REDI. We will now examine two major ECN systems: Instinet and Island.
The former caters principally to inter-institutional trading, and the latter
caters mainly to retail customers.
Instinet. Instinet (Institutional Net) was the first ECN. It was developed
so that institutions could bypass brokers by displaying bids and
offers directly to one another. In the mid-1970s, Instinet opened its doors
to brokerage firms, enabling them to participate as active buyers and sellers
alongside the institutional firms. Today, access to Instinet for trading
is limited to member institutions, brokerage firms, and licensed brokerdealers.
Recently, some brokerage firms have given retail customers limited
access to Instinet. You should contact your brokerage firm to find out
what kind ofaccess you might have to Instinet. The symbol for Instinet on
Level II is INCA.
Instinet handles both NASDAQ and listed issues. The Instinet Book
(referred to as the Box) is where all of the orders on Instinet are placed.
The Instinet Book is available for trading NASDAQ and listed stock 24
hours a day. The exact price and size must be submitted.
Hiding Orders on Instinet. There are various levels ofdisclosure available
for Instinet trades. Not all bids and offers on Instinet are disseminated
to Level II. Therefore, you can hide your orders so that only other Instinet
users can see them. Hiding orders is advantageous, because you might not
want to show your true intention or order size and scare off potential buyers
or sellers. You can also hide the exact size ofyour order in the Instinet
Book by disseminating your bid in smaller blocks of shares. Ifyou are trying
to buy 10,000 shares for a designated price, you can hide your volume
to reflect only 1,000 shares at a time. Once 1,000 shares are filled, another
1,000 shares will pop up. This method is a great way to hide a large bid or
offer, but keep in mind that others might realize what you are doing.
Island (ISLD). Island was introduced in 1996 and was the first ECN to
give access to the retail customer.Aretail customer cannot only watch the
order flow on the Island Book, but he or she can also participate directly.
The Island Book market is similar to the Instinet Book market in that
orders have to disseminate price and volume. Furthermore, the Island
Book can be accessed on the Internet with any standard browse:r: Offering
a great alternative to the retail customer, Island has become the second
most popular next to Instinet, which is the largest ECN.
Here are some advantages and disadvantages ofECNs:
1. In general, the main advantage to trading by using ECNs is that
they enable individual investors to compete with market makers on
NASDAQ Level II by bettering the market or by making their own
disseminated market. Individual investors no longer have to trade
with market makers. The investor also can see the exact size and
price of each order placed on the ECN.
2. The main disadvantage with ECNs is that in using them, you are not
guaranteed that your stock will trade. Because there are no market
makers who are making markets on an ECN, no one is required to
buy or sell shares ofstock. You might see a stock on an ECN that has
only offers and no bids. Similarly, ECNs do not have that many
clients or investors participating, which makes stocks more volatile
and further contributes to the problem of limited liquidity. Another
disadvantage of ECNs is that there are so many of them. A stock
might be trading at a price that interests you, but unless you have
access to that ECN, you cannot trade it. Finally; ECN systems usually
charge a fee in addition to the broker's commission.
Other ECNs.
There are currently 10 ECNs that are available to the
retail investor, and the future will evidently bring more. The main issue
with these other ECNs is liquidity: If there is little liquidity; the whole
concept of the ECN is moot. No liquidity equals no trades and increased
volatility: One of the main problems with ECNs is that they are selfcontained
auctionary markets and cannot speak to one another. In other
words, volume is divided between several ECNs, and no one ECN will
always have the best market or enough volume. Currently, the leaders in
the ECN community are Instinet (INCA), Island (ISLD), and Archepelago
(ARCA).
Recently, the PCX has partnered with Archepelago. This partnership
will bring the advantage of using ECN into the world of listed stocks.
The future will be an interesting one, because ECNs will play an everimportant
part as financial-trading instruments. The PCX-Archepelago
partnership is only the beginning, so expect to see ECN-type systems for
other financial products (such as bonds, options, futures, and others). As
long as there is liquidity, there is room for ECNs.
Read More: Executing NASDAQ Orders
