Individual Investors Enjoy Faster Trades And Lower Spreads
Thursday January 23, 10:34 am ET
By Ken Hoover
A little more than a year after regulators required stock exchanges to keep statistics that show how well they execute trades, Nasdaq is crowing about its results.
Nasdaq's executives say investors get a better deal on Nasdaq stocks, whether a big cap or small, large order or small. They say their spreads are tighter and their execution faster.
The reason, says Nasdaq chief economist Mike Edleson, is better technology and competition among market-makers and electronic communications networks, known as ECNs. That, he says, has driven down costs.
"The specialist system is a decent system," Edleson said, referring to the NYSE's road-tested method of filling orders. "It's been around a long time. But the invisible hand really works. What better mechanism to show how the free market works than in the stock market?"
Not unexpectedly, the New York Stock Exchange says Nasdaq's assertions are bunk. NYSE says Nasdaq has calculated its numbers to make itself look better. Presented another way, NYSE has the edge as the better place to trade, its executives say.
Whoever's right, one thing is clear: The retail investor gets a far better deal in the markets than just a few years ago. And it's not just the free market that's made things better.
Edleson says market-makers now have better technology that lets them make trades faster and at lower cost. And that technology is getting cheaper, he says.
Automatic execution of smaller orders has sped up the markets, especially for individual investors.
But Adam Smith's invisible hand shouldn't get all the credit. Government regulators have forced changes on often-reluctant exchanges.
New order handling rules were imposed in 1997 after investigators uncovered collusion among Nasdaq market-makers to keep spreads artificially high.
Around the same time, to narrow spreads, stocks started trading in minimum increments of sixteenths rather than eighths. In 2001, the Securities and Exchange Commission ordered Nasdaq and NYSE to trade in decimals instead of fractions.
These reforms brought down spreads dramatically.
Individual investors were the biggest beneficiaries of tightening spreads. Institutional investors also like Nasdaq's changes.
But big trading desks complain about the effect of decimals on NYSE. They say others can step in front of their bid by a penny, forcing them to raise it.
Investors can assess the deal they get from the markets by looking at execution speed and the spread between the bid and ask price.
When a stock is moving fast, you want your order filled quickly. If it sits around 20 or 25 seconds, the stock might move away from you.
A wide spread means the market maker is taking away more of your investment dollars to make the trade for you.
In July 1996, before federal investigators went after market-makers, the average volume-adjusted Nasdaq spread was 30.78 cents vs. 16.14 for NYSE stocks, according to Nasdaq statistics.
In October 2002, the last month for which Nasdaq provided numbers, the average Nasdaq spread dropped to 2.09 cents compared with 3.35 cents on the NYSE.
Even if you reject Nasdaq's claim it's the lower-cost market, that's a huge improvement.
"Think about that," said Edleson. "The more active stocks are trading 1 or 2 cents all the time."
Edleson says you get pretty much the same results whether you look at the entire market, S&P 500 stocks, mid-cap or small-cap stocks.
NYSE executives don't think much of Nasdaq's assertions.
The main reason Nasdaq looks good is that Nasdaq stocks are down about 60% in the last two years, NYSE argues. Stocks trading at lower prices have narrower spreads when measured in pennies.
"Measuring spreads in cents doesn't make any sense," said Paul Bennett, who heads NYSE's research department. "If you did it in (percentage) points, you'll find that the difference has gone away."
Cents is how the SEC requires exchanges to keep their stats.
Bennett also says Nasdaq calculated volume-adjusted spreads. Those calculations give the highest weights to heavily traded mega-cap stocks, like Microsoft and Intel. Those stocks trade in extremely narrow spreads.
The scientific way to compare NYSE and Nasdaq spreads is to have a matched study, argues Bennett. That means selecting stocks from both markets with similar characteristics, and seeing which have the better spreads.
One such study was done by the SEC two years ago. It looked at 221 Nasdaq and 1,141 NYSE stocks and matched them by market cap, trading volume, price and volatility. It studied trading for the week of June 5, 2000.
SEC number crunchers concluded investors got a better deal on NYSE. That time, it was Nasdaq officials who screamed bloody murder. They said the two markets were so dissimilar they couldn't be compared. The SEC, they said, were comparing apples and oranges by lumping old-line, stable NYSE stocks with young, volatile Nasdaq stocks.
Many of the Nasdaq companies in the SEC study, Nasdaq officials complained at the time, weren't even eligible for NYSE listing.
Nasdaq also looked at execution speed. It claims it beats NYSE in that category, too.
For S&P 500 stocks, Nasdaq says its average order, regardless of size, is executed in 2.5 seconds compared with 24.3 seconds for NYSE. For stocks on the S&P 400 index, Nasdaq beat NYSE with a time of 5.1 vs. 35.5 seconds, according to Nasdaq stats.
NYSE's Bennett concedes Nasdaq is faster because more of its trades go off automatically.
"The question is whether a faster execution is a better execution," Bennett said.
He also noted that NYSE orders of 1,099 shares and below are executed automatically. |
