 Hello and welcome to this session. This is Professor Farhad in which we would look at the rise of electronic trading. This topic is covered in essentials or principles of investments. As always, I would like to remind you to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1,700 plus accounting, auditing, tax, finance as well as Excel tutorial. If you like my lectures, please like them, share them, put them in playlists. If they benefit you, it means they might benefit other people, share it with other and connect with me on Instagram. On my website, farhadlectures.com, you will find additional lectures and resources for your finance as well as your accounting courses, CPA exam as well as CFA exam. So the purpose of today's session is to take you through a brief overview about electronic trading over the years and which regulation influenced that electronic trading. First thing we're gonna start in 1969. This is where we had the first ECN, electronic communication network called Instanet. And basically what are the ECNs and now they are pretty famous in common. So basically it's a computerized network that facilitate the trading of financial product outside the traditional stock market exchanges. So simply put, it's a network. It's a network that you could trade stocks on. You don't have to go through an actual exchange. Think of it, you can think of it as a primitive internet where you can place trade electronically and those trades match each other like on the internet but before the internet existed. In 1971, we started to have what's called the National Association of Securities Dealer introduced the automated quotation system or known as NASDAQ. It linked the brokers and dealers in a computer network. Basically the same thing, however, at that point NASDAQ was only designed for price quotes. So they could display and revise quotes. Today the NASDAQ has over 3,000 shares on it and thousands of dealers involved with it but it all started just basically a system. Think of it as a screen telling you what the prices are. Now, if you wanted to buy or sell stocks, you would have to call that broker that's showing that price and you will have to negotiate with them. Now over the years, the NASDAQ became more of a stock market by adding trade, volume reporting and automated trading system. Now NASDAQ would allow you to execute trades. Actually most of the trades are executed on the NASDAQ. By 1981 NASDAQ traded 37% of US securities which is total of 21 billion shares. 10 years later, it's went up to 46%. So notice it was taken over and it's still taken over. But really what started to change things is in 1975, the fixed commission on the NYSE was eliminated and this freed broker to compete for business by lowering your fees. When the fee is the same, you cannot compete. Once the exchange said, well, you could basically charge any fee that you want to, then the brokers can compete in lower their fees if they want to. So Congress amended the Securities Exchange Act to create a national that's also in 1975 to create what's called a national market system to centralize trading. Now by that time, by 1975, it was not all centralized but the point of it is to centralize trading across exchanges and enhance competition among different market makers. Simply put, all these ECNs try to kind of integrate them into one system. So it gives traders a broader view of trading opportunities across market. It doesn't mean by that time they achieved that goal but that was the goal is to go there where you have a centralized system. In 1994, there was a scandal at the NASDAQ and basically the scandal was about the bid ask spread. Dealers were found to be colluding to maintain a wide bid and ask spread. What is bid and ask? Basically bid is what the dealer is willing to buy the stock at and ask is what's the dealer is willing to sell the stock at. For example, here let's assume a dealer was willing to buy a 30 sell at $30 and a half and 50 cent. So simply put, the dealer is making half a dollar or 50 cent because of the spread. So what's wrong with this? For one thing, for now, this spread is pretty wide but the problem with that is trades from other dealers that had a lower spread like they're willing to buy a 30 and one eighth, which is better than 30 and they're willing to sell at 30 and three eighth which is better than selling at $3 and 50 cents were not made available to the public. So as a result, what happened is the public was paying a higher for buying stocks because the spread was wide. Spread was wide. It means more profit in the pocket of the dealer of the NASDAQ dealer. When these practices came to light, obviously the government intervened and anti-trust lawsuit was brought against the NASDAQ. In response to these scandals, also the SEC instituted new order handling rules. Now, for example, published order quotes now had to reflect limit order of customers. In this way, other dealers, they can capture the trade as well. So you have to let them know what limit orders do you have. So if I can fill that limit order, I will fill it for you and other dealers. Also, the new rule integrate quotes from ECN, the electronic communication network into public display. Now remember those kind of, you have to have access. Now you could see those enabling the electronic exchange to also compete for trade. Simply put, more competition means lower bid-ask spread. Lower bid-ask spread means lower expense for people who are buying and selling stocks. So shortly after the settlement, the SEC adopted regulation ATS, which is the alternative trading system, given ECN's right to register as a stock exchanges. And as a result, what happened is they captured an ever larger market because what you want mean, if you want to trade quickly, you want the computers to be doing so, not the human because computers can match the order much, much faster. And in the wake of this new competition, the bid-ask spread narrowed. Of course it's gonna narrow. Also in 1997, the SEC allowed the minimum tick size to fall from one eighth to one sixteenth. And I still remember I was studying for my series 99, either late 99, early 2000, I believe, and I had to learn all about the one sixteenth. So before it was one eighth, now it was one sixteenth, which is they reduce the bid-ask. Then eventually after I passed my series seven, and I hated studying for those, is in 2001 they allow the decimalization for the tick size to fall even one pennies. So for example, now prices are quoted and for example, $30.25 for the bid, we'll buy it for that much and we'll sell it to you for $30.28. So it's by pennies, but the similization rather than the one eighth. And notice what happened as a result for the bid-ask price. Notice it went down eventually and now it's down to almost three pennies and even less for highly-traded stocks. It's few pennies, the bid-size ask. In 2005 the SEC adopted a regulation called the National Market System and this is when they really tried to integrate everything which was fully implemented in 2007 and this is where they link all the exchanges electronically creating in effect one integrated electronic market. So which is really good. So now require exchanges at this point to honor quotes of other exchanges when they could execute automatically. So it's no longer basically you have different ECNs. Now all the ECNs, all the market are all integrated together in one system and any exchange that could not handle a quote electronically would be labeled as a slow market under this regulation and could be ignored by other market participant. So if you really want to stay as part of the market you have to honor the prices and execute them fairly quickly. So this way it's in the best interest of everyone. Also the NYSE who was still devoted to the specialist system were particularly at risk of being passed over because look you cannot compete with the computer because the computer can execute at a faster pace and a higher volume than a person. In response to this pressure it moves aggressively toward automated executions of trade as well. So basically it lost its effective monopoly in trading. Okay its own listed stocks and by the end of 2010 its share of trading fell from 75 to 25 of its own stock stocks that are listed on the NYSE. Now they are traded electronically. Today most of the trades are done electronically at least for stocks, bonds are still traded primarily in the dealers and the dealers market. Next session we would look at new trading strategies. Please if you like this recording please like it, share it, put it in playlist and don't forget to visit my website farhatlectures.com if you want the supplement or compliment whether you're finance courses or your accounting education. Good luck, stay safe and study.