It seems that what’s good new for individual investors, may not be so for institutional investors. New York Stock Exchange (NYSE) specialists, whose mandate is to facilitate trading traffic, can use their preferential floor position to raise bids or asks by one cent.
So far, this has improved prices for individual investors, but institutional traders now say they are being “pennyed” by the specialists who get in front of large orders for just one cent.
Under pre-decimalization trading, which existed since the NYSE was founded in 1799, specialists would have to advance the price by 1/16, or 6.25 cents, to step ahead of an order. Decimalization just lowered the ante.
The NYSE converted to decimalization after discussing the proposal for at least a decade, on January 29, and the NASDAQ Stock Market intends to do so as well in coming weeks.
As a result of this conversion, some institutional traders say they are curtailing their use of limit orders, which specify a set price to trade a stock, as well as using more alternative trading systems, such as Electronic Communications Networks and crossing systems, which pool liquidity and have different trading methods.
As a result of the penny practice, the NYSE said it is meeting with its institutional customers to discuss the practice and what, if anything, can be done to rectify the practice.
Opening the Book
To remain more competitive, the NYSE plans to open the specialists’ books that contain all limit orders via an electronic system. The leather bound specialist book is considered one of Wall Street’s most valuable franchises since it gives an NYSE specialist the right to make markets and also trade for their own account in some of the largest corporations on earth.
One key benefit of the specialist book is that it reveals where market momentum is coiled by seeing where limit orders hang. Currently, only specialists have this information.
The NYSE has been under pressure for years to open specialist’s book. Institutions now fear those large orders may divulge their intentions. But there are other trading venues aside from the NYSE which offer different ways to trade whole portfolios or settle stocks at a volume weighted average price or the mid-point between the bid-ask spread. Many of those systems report higher volumes in 2001.