Surge in program trades has NYSE looking at rules Tue Nov 23, 2004 12:58 PM ET By Brendan Intindola
NEW YORK, Nov 23 (Reuters) - The New York Stock Exchange is re-evaluating its rules to more effectively govern the explosive growth in computer program trading.
NYSE regulators are already investigating brokers for suspicious end-of-day trades designed to attain specific prices at the close. Programs play a key role in this late-day volatility, experts in market structure say.
"A lot is going to center around the definition of program trading," said Robert Hegarty, of technology consultant TowerGroup. "The New York Stock Exchange will have to tighten up their rule about what a program trade is.
"Just look at the trades at 3:30 p.m. There are so many computer programs that look at where the market is at that time. It is creating an enormous amount of volatility and uncertainty in the final minutes of the day."
Eugene Noser, a 40-year Wall Street veteran agrees.
"The closing price is the most manipulated price of the day," said Noser, who since 1975 has been president of Able/Noser, a firm that helps big investors reduce trading costs and implement investing strategies with programs.
HUMANS FADING
Program trading now account for more than half of the average daily volume on the Big Board, up from about 15 percent five years ago and about 40 percent one year ago.
"Humans are fading and technology platforms are moving in, trading multiple instruments," said Randy Abernethy, who in 1997 co-founded UNX Inc., one of the leading vendors of computer trading technology.
The chance of a 1987-style selling spiral caused by index- arbitrage programs is small, experts say, because now there are scores of different buy and sell programs.
An NYSE spokesman confirmed the program-trading rules are under review. Right now, the rule fails to cover a large portion of program activity since it defines program trading as index-abitrage, or trading a basket of 15 or more stocks with a value of at least $1 million.
Programs "have become quite elaborate," Noser said. "You can have a hedge fund with a program to go long tech stocks and short drugs stocks. The definition has not changed since it was put in, way back in the 1980s, prior to the 1987 break."
HYBRID, REGULATION NMS
Also forcing modernization are two imminent changes in the broader market regulations that will profoundly affect buying and selling.
Both changes will increase the electronic linkage between equity markets, opening up new avenues for program trades.
The first is the elimination of many limits on electronic trading at the NYSE under its proposed "hybrid market" plan currently under review by the U.S. Securities and Exchange Commission. The plan was unveiled in August.
The other is a set of new SEC regulations that are expected to compel more brokers in more markets to execute at the best available prices.
The NYSE historically has supported the "trade-through" rule that prevents "trading through" best prices, usually for reasons of speed. Electronic markets and the Nasdaq have argued against the rule, given their digital swiftness that some big investors prefer over prevailing price.
While there are many different types of programs to trade stocks, common attributes include sweeping across multiple equity markets for the best prices with lightning speed and complete anonymity.
Large blocks of stock are sliced into small orders with predetermined buy or sell prices. The market sweeps can be timed at regular intervals and can expire after a set time. Programs can also test the waters, using months or years of historic tick-by-tick price data.
Long the domain of Wall Street's "sellside," or the big Wall Street brokers, a key reason program trading is expanding rapidly is the increasing use of programs among big "buyside" clients. Institutional investors are looking for the same advantages long enjoyed by the other side of the Street.
The trend is also driven by the rise of hedge funds, exchange-traded funds and indexing, or investing to mimic an index.
Noser points out that hedge, index and exchange-traded funds must rebalance their holdings to match the weightings in whatever index their investments track.
"You rebalance them on a weekly, month(ly), quarterly basis and you have programs to do this, Noser added.
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