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Tuesday, 07/10/2007 11:52:36 AM

Tuesday, July 10, 2007 11:52:36 AM

Post# of 12022
Good artcle from Barrons on the computerization of the stock exchange.

You can't complain about marker maker manipulation anymore because they're going to be gone and computers will take their place.
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U.S. Exchanges' Need for Speed

By JON NAJARIAN - JULY 6, 2007

I BEGAN A CAREER IN TRADING SOME 26 YEARS ago, after a brief stint with the Chicago Bears football team. To some "a brief stint" seems like an exaggeration, since I never played in a regular-season game and yet, in my mind's eye, each day with the Bears is full of memories I will never forget.

Starting at the Chicago Board Option Exchange (CBOE) and having traded at the Pacific Stock Exchange, the New York Stock Exchange, as well as a host of exchanges and trading desks across Europe, I've observed market transformation that's as vivid to me as my time in pro football. In my field, things have been changing nearly as profoundly as the speed of trading itself, for the business today is in the middle of an unprecedented "arms race" for speed.

Back when I started, it was against exchange rules to have computers in the pits of Chicago's trading floors. There were several reasons why such policies were in place. First there was the size of computers in 1981. Then there was the culture of open outcry trading. Trading opportunities were gained by those with quick, analytic minds, loud voices, and guts, not by those with computer horsepower and massive capital behind them.

The relentlessly falling cost of computers would undermine the traditional way of trading, as only those who could afford the newest systems and their continuous support would enjoy the edge they brought. Furthermore, the speed at which electronic trades could be done would augment the value of computational horsepower. Volume made up for ever-shrinking margins.

In 1981 the average daily volume of trade on the four U.S. options exchanges was 435,000 contracts per day. At that time the NYSE would trade under 50 million shares virtually every session. Contrast that with 2007, when we see an average day produce 10.5 million option trades on six U.S. options exchanges and an average of over 2 billion shares on the NYSE, and you see the difference electronic computation and speed of execution have made to our markets.

These results were just as predictable as the time of the sunrise tomorrow. As the exchanges had fretted, computing power and connectivity all but took the individual floor trader out of the equation, and the overhead costs meant individual traders and small groups were forced out as margins contracted with each new gigahertz of speed.

Although the advances in telephony have brought prices down for Internet connectivity, the cost to remain a top-tier player get higher every day. Presently optionMONSTER pull its quotes through six 1-gigabyte circuits, so that we can read and respond to the roughly 100,000 quotes per second that stream from the U.S. option exchanges. To put that in perspective, a DSL connection to the Internet costs perhaps $49 per month and pulls at top speeds of 192 kilobytes per second. An OC3 connection will run you $7,000 a month and pulls at about 50 megabytes per second. Our 1-gigabyte circuits pull through a gigabyte of data per second and run about $20,000 apiece per month.

There are two overriding reasons U.S. exchanges have put the pedal to the metal and have turned trading into a supersonic derby we see every day. The first is that the faster exchanges let members trade, the more those same members will trade. Today's record volumes are clear evidence of that.

Additionally, U.S. stock and options exchanges aren't just facing domestic competition, but formidable foreign competitors as well. The London Stock Exchange has just cut its information dissemination time from 30 to just 2 milliseconds, making the LSE the fastest track in the world. The first trading day on their new system (June 18) the LSE volume increased nearly 6%.

Algorithmic trading, faster computers and gigabyte connectivity to the Internet have helped make exchanges the darlings of the investment world, and they've also made for far more depth and liquidity for the end users. The pools of liquidity that the six U.S. option exchanges draw from have never been deeper. And just as no speed limits on the professional side of trading has brought more players to the party, so will those market makers make it more fertile for the market takers.





MW

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