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April 30, 1999

Locked and Crossed Markets

By Michael L. O'Reilly

Also in this article

  • Locked and Crossed Markets

Locked and crossed markets are a reality of Nasdaq trading. They always have been.

But in recent months - with online investors flooding the market with orders, and some electronic communications networks (ECNs) refusing to trade with certain market makers - markets in Nasdaq stocks are locking more frequently than ever before.

"Firms are locking the markets without trying to reach the other side, and ECNs aren't trading with some market makers because they refuse to pay [access] fees," said Nicholas Ponzio, managing director of Jersey City-based market maker Hill, Thompson, Magid & Co.

"These problems didn't exist in the past. It's dissecting the market."

In normal situations on Nasdaq, the best bid, or buying price, is slightly lower than the best offer. The difference is the market maker's spread. But when a market becomes locked or crossed, the best bid will be at the same price as the best offer, or higher.

So in a normal situation, the best bid on ABC Corp., for instance, could be $10 a share, with the best offer higher, at $10 1/4. In a locked market, the best bid and the best offer would both be at $10. In a crossed market, the best bid would be at $10 1/4, with the best offer lower, at $10.

According to the National Association of Securities Dealers, Nasdaq averaged 104 daily locked or crossed markets of one minute or more in January. Nasdaq averaged 51 locked or crossed markets a day last August, and only 22 daily locked or crossed markets the previous January.

Averaged out, three-tenths of one percent of all daily quotes on Nasdaq were locked and crossed for a minute or more in January.

Last August, only two-tenths of one percent of all daily Nasdaq quotes locked. In January of 1998, just one-tenth of one percent of all daily quotes locked or crossed the market.

With 327,303 Nasdaq inside-quote updates a day this January, 104 locked or crossed markets may seem insignificant. But tripling in frequency over last year, locked markets have become a greater frustration for market makers and broker dealers seeking executions.

"It's a real problem," said Ben Marsh, managing director of over-the-counter trading at Adams, Harkness & Hill, a Boston-based market maker. "The system is out of whack. It's got to be cleaned up somehow."

Market makers and broker dealers cite two factors for causing the tripling of locked and crossed markets over the last year: the boom in online orders, and ECNs refusing to trade with certain market makers which have not paid access fees.

Online Exuberance

According to London-based Reuters Corp., first quarter online trading volumes in the U.S. rose more than 30 percent from the fourth quarter of 1998, to 450,000 trades a day. That surge in online trading volume came despite overall market volume rising less than five percent.

With online volume booming, broker dealers handling online order flow have struggled with the glut of new business.

"There are so many more participants, so much order flow, so much business," said Dan Kravits, director of Nasdaq trading at Chicago-based market maker EVEREN Securities. "Things are happening so much faster than they ever did. Nasdaq itself can't handle the influx of orders and make sure the markets are set up appropriately."