Equity Market Structures
Open Outcry
As already indicated, players in this trading system use hand signals to communicate their intention to either buy or sell securities. This system has been in place for a very long time. In order to express the intention to buy, the professionals in this system hold up their hands, with the palms facing in (Rogow, 2009). When they want to sell, they do the same only that their hands face out and are placed away from the body. These professionals use several signals to communicate information regarding their trade intention. As evident, this system requires that the various persons involved be in a particular trading area, which is usually referred to as trading pit. All of the investors wishing to trade in these securities assemble at this point for business (Garfield, 2000). The wisdom behind this is that when a market functions as an auction, there is a higher possibility of an efficient market prevailing. This means that the person willing to sell quotes the price they want to sell at, then those interested in buying place their bids. The person that makes the highest bid gets the securities. It is assumed that the congregation of both buyers and sellers at this point brings about mutually consented prices.
Electronic Communication Networks
As indicated earlier, ECNs are automated systems of trading. In other words, orders to either sell or buy are automatically matched by a computer, at prices that are already specified. This system differs greatly with the open outcry in that it allows not only market makers and broker-dealers, but also individual investors as well as institutional investors to directly place trades with an Electronic Communication Networks (Rogow, 2009). There is a requirement however, that in order for the individual investors to have their orders routed to an ECN, they must open an account with a broker-dealer. Individuals seeking to trade in securities normally use limit orders (U.S. Securities and Exchange Commission, 2009). These orders are then posted by the ECN to the system where they become visible to other subscribers. When there are orders for matching, the system automatically matches them for execution. This means that only when there are matching orders can there be a transaction. As is evident, this system does not require that persons be physically present, as in the open outcry system, on a trading pit (U.S. Securities and Exchange Commission, 2009). The disadvantage with this system is that only those who are registered with an ECN can gain access to this form of trade. It is also not possible to assess the intention of the traders because there is no direct interaction. At the same time, persons wishing to sell their shares may end up not doing so, if there are no matching orders, which would be done physically in the open outcry structure.
NASDAQ Stock Market
As earlier indicated, NASDAQ makes use of electronic screens to trade in equity securities. It is considered to be the largest of its kind, dealing with over 3700 organizations (NASDAQ, 2009). This makes it the market that has the largest trade volume in the whole world. NASDAQ became the first electronic stock market in the world, starting out as a computerized bulletin board. One remarkable thing that NASDAQ did was to succeed the over-the-counter (OTC) trading system. It provides price quotations on over five thousand stocks that are actively traded over the counter. It is worth noting however, that the stocks of NASDAQ are not placed into the OTC category, because it is currently a stock exchange (NASDAQ, 2009). NASDAQ is considered to be operating as a dealer network. Unlike the open outcry system, dealers in the NASDAQ do not operate from a physical trading pit rather they work through a kind of a telecommunications network. In this case, investors and their buyers or sellers are directly involved in trade. This is made possible by a chain of electronically interconnected companies. The importance of having direct physical interaction between traders is that it not only allows for negotiations, but also a possibility of reading the mood as well as the intention of the partner. This is not possible when using NASDAQ as the avenue of trade, because interaction is only possible electronically.
Similarities between the Open Outcry, ECN, and NASDAQ
A common reality among these three is that, all deal with the trade of securities. It is worth noting that there are some similarities that appear in two of these three, rather than in all three. For instance, the ECN and NASDAQ are both electronic means of trading securities. They both eliminate the need for a physical presence. However, all of the three systems require that for a sale or purchase to be completed, there must be some kind of matching of the offers. For the open outcry, the deal is struck with the highest bid being matched with the lowest asking price. In the ECN, the orders available for buying and selling are matched at a specific price in NASDAQ, the market-maker matches the securities so that a transaction is possible.
Differences between Open Outcry, ECN, and NASDAQ
A very clear difference between open outcry and both the ECN and NASDAQ is that, the last two use electronic devices to conduct business. Whereas open outcry requires that people shout out their proposals, the other two systems are more orderly in that it only requires computerized kind of communication (Investopedia, 2010).
The NASDAQ differs from the open outcry system in that whereas the former operates through a dealer, often known as a market maker, the latter is a kind of auction, where the highest bidding price gets matched with the asking price that is lowest. What this means is that investors in the open out cry system deal directly with each other. In NASDAQ, a market-maker purchases securities and holds them, waiting for those interested to come and purchase them, thus making their profits (U.S. Securities and Exchange Commission, 2009). Ideally they make the market, that is why they are referred to as market makers.
The open outcry requires a physical presence, whereas both NASDAQ and ECN do not. One does not have to be there physically, because trade is in this case made possible electronically. The ECN differs from the others in that it allows for trade after the official hours, because it only requires that orders be available (Oakes, 2005).
The Future of Open Outcry Structure
Some people have argued that this system will be replaced by an electronic trading system. Although the traditional system has remained strong, for instance the New York Stock Exchange (NYSE), it is very probable that this system will be totally replaced. The reason for this claim is that the electronic system seems to have a lot of advantages compared to the open outcry system. Electronic systems eliminate the waste of time witnessed in the open outcry system because the matching is instantaneously done by the machine. At the same time, it offers a cheaper option, because the costs incurred in the traditional system are no longer necessary. Both the dealersbrokers and the market-makers can potentially manipulate the system. However, with an electronic system, chances of this happening seem to be fewer. Furthermore, the electronic system has proven to be more efficient than the traditional one. Michie Ranald, an accomplished financial historian, seems to agree with this assertion. He sees the evolution of the securities market as being far from over. The shift already witnessed implies that a lot more is yet to be seen. It is for these reasons therefore, that I agree with the claim that the traditional system is very likely to be replaced by an electronic system.
Conclusion
As already mentioned the face of the equities market has been undergoing changes which can only be considered revolutionary because these changes mark a paradigm shift from the traditional way of trading. The open outcry structure, which is the traditional way of trading, requires that investors be physically present for trade to actually take place. It involves making pronouncements regarding the expectations of the various parties involved. The ECN does not require that persons be physically present in order for trade to take place. It involves a network of communications, which makes trade possible through automated matching of offers. As aforementioned, this system makes it possible for traders to operate even without official trading hours.
The NASDAQ stock market does not require that investors be present physically in a trading pit. On the contrary, it involves persons interacting electronically through a network, in the presence of a market-maker in order to conduct business. The market maker does the matching of orders, making the trade possible and smooth.
However, all of the three systems require that for a sale or purchase to be completed, there must be some kind of matching of the offers.
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