Jessica Davison - Competition on the Nasdaq and the Growth of Electronic Communication Networks

Citation: Fink, Jason, Kristin Fink, and James P. Weston. "Competition on the Nasdaq and the Growth of Electronic Communications Networks." The Journal of Financial Services Research (2004): 1-37.

Link:

Competition on the Nasdaq and the Growth of Electronic Communication Networks

This article discusses the growth of ECNs which are electronic trading systems and how this growth has affected the Nasdaq. “Competing directly with Nasdaq dealers, ECNs offer a low-cost and anonymous alternative to traditional trading”. What I liked about this article is that it examined the affect of ECNs on stocks over a six year time span in order to better understand what was changing in the market.

I found a number of things fascinating about this article. First, I had no idea that ECNs allowed anonymous trading, I honestly never considered that using a traditional broker forced people to give up their anonymity. The article pointed out that people are more likely to place orders if they have anonymity, “even though they are usually smaller orders and have lower fill rates compared to traditional dealers”.

This does not make complete sense to me. I understand why more people would want to trade if they had the option to trade anonymously, but I do not understand why it is mostly smaller transactions. This also raised a question in my mind: with the use of ECNs does it become more difficult for the SEC to regulate transactions? While this article does not focus on this issue, I hope to find future articles or information that discusses this further.

This article was also interesting because it had evidence that prior to the use of ECNs the Nasdaq markets were often not efficient and often shut out a large segment of the population due to collusion. I found it very interesting that between new legislation passed around 2000 and the growing use of ECNs that the market has now become more competitive, more efficient, and now more people appear to have a more fair chance to get in and have the chance to make money.

Given our class discussion last week, I started to almost feel bad for some of the brokers who are losing business to the ECNs. However, this article points out that this IT development has helped more people become involved in trading, which only benefits the Nasdaq, trading community, and economy as a whole through increased competition which is allowing more people to be able to enter the market.

However, despite the conclusions drawn in this article, that ECNs are benefiting the market as a whole, there are some negative effects considered. For one, ECNs fragment the market so that orders are placed through many different centers instead of one central place, leaving the “potential to reduce overall market quality”. Anonymity is also a potential negative along with forcing some traditional dealers out of the market. However, although the article stated that although ECNs “may have a negative effect on the ability of firms to profitably purchase order flow,” ECNs have improved the “long-run structure, conduct, and performance of the Nasdaq market.”

This article is extremely interesting, it shows how research was conducted and clearly spells out the results of this long term study. Prior to reading this I was a little on the fence about whether ECNs were an overall positive development. However, now I feel much more confident that the development of this technology is overall a positive step for the market.