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1 The Stock Exchanges and Alternative Trading Systems... listing and trading conduits , Gary R. Evans. May be used for non-profit educational purposes only without author's permission.

2 Topical: The market reaction to Apple's murder of the 3.5mm jack (iphone 7):

3 Listing versus trading Listing... and for the retail trader, this doesn't really matter (much). NYSE NASDAQ NYSE (Arca) NASDAQ BATS (plus regionals and ATSs) Trading

4 Electronic Communications Networks (ECNs) [1998 Reg ATS: Alternative Trading Systems] Authorized fully electronic trading and clearing networks Most were originally independent, and designed to compete with NASDAQ and NYSE, but many were absorbed (Instinet, Archipelago, the Island) and others have become exchanges. Oldest (pre reg-ats) was Instinet (1960), specializing in institutional trades, purchased by NASDAQ. Some specialized in after-hours trades (normal trading hours are 9:30 to 4:00 EST). They introduced low-latency full automated (computerized) trading.

5 The 2005 Game-Changer Mandate: The SEC Regulation National Market System (Reg NMS) This massive mandate, created in 2005 and now being implemented, was intended to create a competitive, selfregulating, g, and largely automated national market system for securities. Among its features: 1. Consolidated tape for all exchanges. 2. Rule 611 orders trade at the best possible price (NBBO). 3. Standardized trading rules to be followed. 4. Rule Equal access to all markets by all players.

6 So what, precisely, is a stock exchange? A stock exchange is any ECN or physical exchange that legally adopts rules for itself and its members that comply with the requirements of Reg NMS, subject to approval of the SEC. The technology used by the exchange, for example for order routing, must be capable of insuring this compliance. There are currently 3 large trade groups that meet this criteria: 1. NYSE 2. NASDAQ [OMX] 3. BATS Global

floor (formerly open-outcry).* outcry) 2. NYSE Arca the fully electronic exchange Purchased Archipelago, an ECN, in 2005. 3.

7 NYSE 3 US dedicated exchanges 1. NYSE the traditional physical exchange located at 1 Wall Street, hybridized electronic but with some people still on the floor (formerly open-outcry).* outcry) 2. NYSE Arca the fully electronic exchange Purchased Archipelago, an ECN, in NYSE MKT now dedicated to listing and trading small-caps. Historically i evolved from the NYSE purchase of the old American Stock Exchange. *I no longer describe the workings of the physical exchange in these lectures.

8 Major Exchanges NYSE [owned by ICE] Retains physical exchange - 1 Wall St. NYC Oldest and most traditional i of US exchanges 1792 Originated the open outcry system, but slowly converted to pure electronic. Merged with EuroNext in which was formed by merging Amsterdam, Brussels, and Paris exchanges (2000), then acquired London derivatives market (LIFFE) and Portuguese exchange, making it the largest crossborder market in the world. Was bought by a Intercontinental Exchange (ICE) in 2013 which is a holding company that began as a natural gas trading company (!) and now trades, through subsidiaries like NYSE and Euronext, stocks, options, ETPs, commodities, credit instruments, f t f i h ti ll thi! futures, foreign exchange essentially everything! NYSE opens stocks with the result of an electronic auction.

9 NASDAQ OMX Group National Association of Securities Dealers Active Quotation tti system - no longer associated w/ NASD Decentralized electronic exchange since ,070 companies listed on NASDAQ OMX in 50 countries (2,780 in the U.S.). INET global high-speed trading platform (former ECN acquired in 2007) NASDAQ listing and trading are separate functions Still a huge player, but now the market is chopped up.

10 The newcomers BATS Exchange and Direct Edge (now BATS Global, the pure technology play) Both started as ECNs (ATCs) Both aspired to SEC Reg NMS compliance Both were global Both sold mostly speed and low cost (and NMS compliance) The secret on speed is order routing that is NMS Rule 611 compliant. Both were active in options trade (Tape B trade). BATS Global l bought Direct Edge on August 26, BATS scans against dark pools (explained later). BATS appeared to be aggressive at attracting algos and market makers.

11 DWBH! NYSE pre-market open auctions (price discovery) (This is too much to expect a beginner to understand, but it is useful to know in times of Trubba. This slide is explained by example). Source: NYSE ARCA Auctions (pdf)

12 Taxonomy: Exchanges, ECNs, and Dark Pools Exchanges: NYSE NASDAQ BATS Alternative Trading Systems ECNS Dark kpools (list on PBBO) (do not list on PBBO) Want to become an exchange In-house client clearing Large block client clearing (large into small)

13 Big problem: Large trades and market impact! Large institutional traders like mutual funds and hedge funds often want to trade huge blocks of the same stock (e.g. 100,0000 shares) over a short period of time. But tthey want tto do it anonymously, because if the market knew their intentions, other traders could game the transaction. They want to trade without market impact! So the market must provide liquidity to these traders (have enough stock out there being sold and bought on spec and arbitrage to offer sufficient volume for these large block trades) without market impact. REG NMS doesn t do this. Traditionally these large block trades were broken up and handled d anonymously in pieces, and they still are to some extent, but now they are just as likely to be handled by dark pools.

14 Dark Markets and Dark Pools Dark markets do not publicly post their transactions you won't see large block transactions on NASDAQ TotalView, although you will see pieces of them if and when they are broken into smaller trades Crossing Networks that match large blocks off-market (non PBBO) 47 of them (ATS) as of July 1, Dark pools are ECNs that trade dark market transactions The SEC allows them to facilitate secret large block trades because an informed market would go against the trades What if someone knew you were trying to sell 300,000 shares of F? Dark pools must report trades monthly on Reg NMS Rule 605. Dark pools seem to account for between 15% and 30% of total market volume.

Example: Dark Pool reference point crossing The NYSE crossing procedure involves

predetermined one minute pricing periods.

15 Example: Dark Pool reference point crossing The NYSE crossing procedure involves finding a reference price from the mid-point of the NBBO quote randomly selected from predetermined one minute pricing periods. Periodically participants can cross at that price. See Also for a discussion and example of how Internet Sweep Orders can fit into this in procedures used by the NYSE, see NYSE Hybrid Market Training Program, Sept. 2006, available from the NYSE in pdf.

16 (ATS) trade size on average is small...??? ATS Name MPID Total Trades Total Shares Average Trade Size UBS ATS UBSA 71,193,431 11,732,722, CROSSFINDER CROS 47,884,201, 9,068,237,624,6 189 IEX IEXG 41,389,239 8,926,170, SUPERX DBAX 31,960,164 6,445,196, MS POOL (ATS-4) MSPL 21,561,341 5,563,274, JPM-X JPMX 14,960,971 3,703,039, INSTINCT X MLIX 16,793,293 3,631,461, LEVEL ATS EBXL 18,679,448, 3,218,478,700,, 172 BARCLAYS ATS ("LX") LATS 17,941,839 3,215,815, SIGMA X SGMA 16,982,640 3,184,857, BIDS TRADING BIDS 4,077,489 2,738,538, INSTINET CONTINUOUS BLOCK CROSSING SYICBX 11,681,682 2,683,226, KCG MATCHIT KCGM 15,436,401 2,657,290, POSIT ITGP 6,870,644, 1,972,460,300,, 287 CROSSSTREAM XSTM 3,377,351 1,671,915, MS TRAJECTORY CROSS (ATS-1) MSTX 5,826,598 1,093,985, IBKR ATS IATS 2,926, ,641, MILLENNIUM NYFX 2,815, ,132, LIQUIDNET ATS LQNT 20, ,059,070 41,569 PDQ ATS PDQX 4,104, ,774, CITI CROSS CXCX 3,113, ,045, DEALERWEB DLTA 1, ,843, ,896 BLOCKCROSS BLKX 50, ,672,664 12,287 LIGHT POOL LTPL 2,751, ,843, LIQUIDNET H2O LQNA 33, ,157,900 11,152 INSTINET CROSSING XIST 61, ,654,602 4,269 TRADEBOOK BTBK 992, ,393, MS RETAIL POOL (ATS-6) MSRP 320,761 90,069, LIQUIFI LQFI 4,205 79,449,521 18,894 LUMINEX TRADING & ANALYTICS LLC LMNX 2,128 71,101,637 33,412 AQUA AQUA 4,314 47,511,641 11,013 MERRILL LYNCH (ATS-1) MLVX 70,291 23,342, RIVERCROSS RCSL 99,727 20,957, XE WDNX 8,711 12,643,427 1,451 USTOCKTRADE SECURITIES, INC. USTK 13,339 3,018, BARCLAYS DIRECTEX BCDX 50 1,137,412 22,748 PRO SECURITIES ATS PROS 26 90,800 3,492

17 Market Makers (a disappearing breed) Market Makers were large trading firms who are committed to provide market liquidity through active bidding, buying and selling in designated stocks. (Important see Ch. 2). For NASDAQ, market participants have a Market Participant ID (MPID)... these you see as 4-letter symbols on NASDAQ TotalView (Level II). Underwriters for an IPO are required to be market makers for the new stock. For the privilege of guaranteeing liquidity to the market, these MMs had the inside edge on spread arbitrage (defined in the chapter, example later in this set). BUT high-speed traders began to take over that oligopoly and do a better job of it, and they are not required to make the market. Implications!

18 short pipes!! Who are the algo traders? Algo(rhythm) traders, also called hi-frequency traders (HFT)andhi-speed traders, use completely or partly computer programs to generate many lowlatency bids and asks, and by so doing, provide liquidity to the markets. Most market makers are now also algo traders but not all algo traders are market makers. Market makers are required to make a market in their designated stocks, but algo traders in general are not (you can be an algo trader). Some market makers pay for market order routing to come to them. Suppose the MM pays for XYZZX market orders. Suppose the Level 1 Bid and Ask above is represented tdby the MM. MMThen ifmm gets a market ktorder to buy and another to sell they execute at these prices and the MM makes a penny. Algo traders now have sophisticated strategies for trying to get the most out of ISOs and large block trades they put in bids and asks all the way down the queue, then often withdraw them quickly like some sort of bid/ask chess.

From Figure 11, chapter 2 Market Makers,

19 From Figure 11, chapter 2 Market Makers, Algo Traders, Spread Arbitrage, and Mudd Algo Traders Note the spread: Image captured in September, This is meant to amplify the material discussed in Chapter 2, and is a memo slide. Points: 1. How the market maker plays this and makes a profit through spread arbitrage 2. How the algo trader could trade it but might bail. 3. How you the Mudd algo trader might play this.

Hmmm maybe a few bugs? The flash crash of May 6, 2010 At 10:42 AM PDT I and millions of others watched the DJIA fall about 700 points in 15 minutes in an otherwise quiet day.

20 Hmmm maybe a few bugs? The flash crash of May 6, 2010 At 10:42 AM PDT I and millions of others watched the DJIA fall about 700 points in 15 minutes in an otherwise quiet day. Then it recovered nearly as fast. PG, a DJIA component, is shown here. Accenture and a handful of other stocks fell to one cent, and thousands of share were traded at the price. What happened? Nobody is yet quite sure to this day. It appears that (and when I saw it happen I judged d it to be this) that t a large series of computer generated ISOs wiped off the top of a couple of key queues (like Dow component PG) which sent indexes tumbling, which triggered circuit-breaker shutdowns of algo trades, which removed liquidity and depleted the ask stacks and remaining algo traders and probably ISOs took them down to nothing. (I have seen an entire ask stack disappear from time to time).

21 Circuit Breakers In 2012, the SEC reset system-wide trading stops called circuit breakers, where trade is suspended for a period of time because of extreme market declines. Circuit breakers are set for the market as a whole and "limit-up, limitdown" trading halts are also set for individual securities. The system-wide circuit breakers: Level 1 halt: 7% drop in S&P 500 before 3:25 PM (ET) halts trading for 15 minutes. Level 2 halt: 13% drop in S&P 500 before 3:25 PM (ET) halts trading for 15 minutes (for the second time, given that there has already been an L1 halt). Level 3 halt: 20% drop in S&P 500 suspends trading for the rest of the day. These NYSE circuit it breakers are reset periodically.

22 The Limit-Up Limit-Down Experiment (for individual id stocks rather than the market) For stocks above $3, an Upper and Lower Price Band is established as the reference price +/- 5% (e.g. for a stock that is trading at $100, the upper and lower band is $95 and $105). The reference price is the arithmetic mean of reported trades over the last 5 minutes. Clumsy rule: your teacher's account of Ford on Aug 24, From the Wall Street Journal (see the next slide for context and references): Many traders reported difficulty buying and selling exchange-traded funds, a popular investment in which baskets of stocks and other assets are packaged to facilitate easy trading. Dozens of ETFs traded at sharp discounts to their net asset value or their components worth leading to outsize losses for investors who entered sell orders at the depth of the panic.

23 But Monday, they (circuit breakers) sometimes exacerbated problems by preventing prices from returning to normal levels quickly, according to traders, investors and market observers. Trouble with limit-up/down on Aug 26, 2015 DWBH Source:

The ETF tumbled 34% in early trading, and instead of Mr. Feight s position selling at his target price of $108.69, down 14%, it sold at $87.32, off 31%.

24 ... and why you never use Stop Orders for ETPs (or anything else)... from the Wall Street Journal story in the previous slide: Lansing, Mich.-based dfinancial i adviser Theodore Feight hd had set up an automatic sale* for ishares Core U.S. Value ETF if it were to fall a certain amount. The ETF tumbled 34% in early trading, and instead of Mr. Feight s position selling at his target price of $108.69, down 14%, it sold at $87.32, off 31%. By noon, the ETF had bounced back, and it ended the day down 4.3% at $ I m Im really disappointed, said Mr. Feight, who invested in ETFs for more than a decade. They weren t as liquid as they should have been. * probably bbl a stop-loss market order (not clear from context). t)

25 Over-the-Counter Bulletin Board (OTCBB) stocks See DWBH!

Weeden Market Structure Fact Book

Weeden Market Structure Fact Book June 2018 Updates The New York Stock Exchange criticized the SEC, claiming the proposed SEC fee plan would be too disruptive and could potentially cost investors $1 Billion.