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Non-Tech : Market Makers - What They Do and How They Do It -- Ignore unavailable to you. Want to Upgrade?

To: Savant who wrote (393)	9/14/2000 6:23:48 PM
From: Savant	Read Replies (1) \| Respond to of 429

Every feel like you were getting stuffed like a sausage..you might not have been far off. fortune.com The Long and Winding Road What Really Happens To Your Buy or Sell Order Carol Vinzant Picture this: It's the morning after a big tech-stock clobbering, and you smell a buying opportunity. So you quickly log onto your online brokerage and key in your order. And then you wait. And wait ... as the ticker symbol swims by in a sea of green--up a point, then two, then 22. You start to get nervous, wondering what's going on with your order. You know there's no stock runner racing down to the trading floor, waving your offer to buy 100 shares of eBay at a crowd of sellers. But what really does happen when you place an order? Frankly, we wondered too. So FORTUNE decided to poke inside the sausage factory that is the modern stock market and see. To be honest, the answer turned out to be dizzying. Given such byzantine inner workings, with layer upon layer of brokers, traders, specialists, and market makers, you can't help but wonder whether this crazy system was designed so that each ensuing middleman gets a piece of the action. That's not the case. The structure wasn't designed at all, in fact. It was pieced together over decades--with plenty of string and duct tape--through the uncoordinated efforts of regulators and entrepreneurs. The first surprise is that all those hidden brokers don't make their money by making you pay a premium for your stock. With a market order, you're legally entitled to get the best posted price. Nor do they profit from secret commissions. In fact, many brokers even pay for the privilege of handling your order. They make their money simply by day trading against you, the presumably less-plugged-in retail trader. When you (through a market order) demand to buy eBay immediately, they sell you eBay--but they generally try to sell it out of an inventory they bought at a lower price. If they don't have eBay in inventory, they count on retail traders' knack for buying at the high and then they sell the stock short, hoping they can cover their short position later at a lower price (see Flipping Out). Before the market opens, a dealer may see an impending rush of buy orders from all the people who trade at home after work, explains Bobby Earthman, president of TradeCast. That market maker goes out, buys the stock low, just like "the only guy in town with radar who can see a hurricane coming," Earthman says. "He goes out and buys all the lumber and bottled water, and sells it back to people at a higher cost." And that game is repeated again and again. So as you can see, the retail trader can end up paying for the whole system, just not through explicit fees and commissions. That's the bad news. But there's good news too: It doesn't have to be this way. You can now bypass the whole mess. A few firms are using day-trading software to do what Wall Street had insisted was impractical--simply routing each order to whichever broker, ECN (electronic network), or exchange displays the best price. That may be what you expected was already going on, but it's really a revolution. In the next few years you may be given a lot more control over your order. You'll still have the old-fashioned route, but companies such as Tradescape and TradeCast will offer two additional options. For average investors, smart order routing will find the best price and immediately send your request there. More advanced traders will have the option of picking out exactly where and when to trade. Expect more mainstream brokers to follow suit. Daytec already routes orders to wherever the best price is. When that happens to be a third-market dealer, who pays to get his hands on your order flow, Daytec rebates the customer. Even Charles Schwab is getting in on the act. In February it spent $488 million to buy CyberCorp, which offers a similar direct-access product. And Tradescape, which had $75 million in revenues last year and which has been courted by several brokerages, plans to go public this year. That's the solution entrepreneurs are offering to individuals who want to avoid the convoluted market structure. Meanwhile, regulators are busy plotting to impose an overall structure on the market. Their plan--a consolidated limit order book, affectionately known as the CLOB--pulls all these far-flung orders back to one place. Right now market participants are only loosely linked by screens that display the best prices, and a hodgepodge of systems execute the trades. The CLOB would effectively turn the display-only screens into an actual market that automatically does the trades. Either way, the sausage factory may be coming to an end. ====comp of Partytime and MIR