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The naked truth about new trading techniques

The naked truth about new trading techniques

Murky practices such as ‘naked access’ and ‘flash’ trading raise the question of whether a select few traders have an unfair advantage in the market, says Trends magazine.

March 3, 2010 10:49 by

Would you turn over the keys of your brand new BMW to someone who can’t drive and who’s likely to end up in a ditch?

That’s how Mary Schapiro, the head of the U.S. Securities and Exchange Commission, describes the risks of so-called naked access trading. This misleading nomenclature does not involve hawking an interview with one of Tiger Woods’ many paramours, but rather high-frequency trading by firms that are not registered with a stock exchange but nonetheless trade through members’ accounts.

These entities, normally broker-dealers or hedge funds, use membership identification numbers to access the exchange, seeking faster execution and better pricing. By acting without the sponsorship of an exchange member, they operate without oversight.

This somewhat esoteric practice made headlines recently. A report from Aite Group, a research firm in Boston, claimed that naked access trading accounts for as much as 38 percent of all American stock market volume, shocking market observers and practitioners alike.

As the Obama administration scrambles to restore investor confidence after a year of horrendous market ups and downs and the unimaginable Ponzi scheme perpetrated by Bernie Madoff, regulators are trying to keep current with a growing list of market-beating schemes.

The rapid rise of computer-led trading and emergence of new trading venues, both geared towards speedier executions, lower prices, and anonymity, have attracted the scrutiny of regulators concerned with transparency and oversight of the markets.

Ironically, some of these developments were spurred by the SEC’s past concerns that the near-monopoly in the trading of listed shares once enjoyed by the New York Stock Exchange and others resulted in too-high spreads and fees.

Allowing the emergence of new computer-assisted trading venues has meant narrower spreads but, some say has resulted in a drop in transparency.

It has also meant, according to spokesman Ray Pellecchia of the NYSE Euronext, a decline in that institution’s share of listed issue trading to 25 percent today from about 70 percent five years ago.

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