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April 1, 2000

Unlocking, Uncrossing Nasdaq Stock Market Requiring Lockers' to Trade 5,000 Shares

By Peter Chapman

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  • Unlocking, Uncrossing Nasdaq Stock Market Requiring Lockers' to Trade 5,000 Shares

Nasdaq will introduce next month a rule change it hopes will cut down on the number of markets that open locked or crossed. The problem is that most market makers don't think it's enforceable.

The much-flouted Rule 4613(e), which loosely regulates locking and crossing of quotes by market makers and electronic communications networks, has been overhauled. Market makers' will be hit in the pocket book, forced to buy or sell at least 5,000 shares, if they flout the new requirements.

The amendment by the National Association of Securities Dealers goes into effect on May 15, which is the same day Nasdaq implements its SuperSOES system.

Under the rule change, if a market maker locks or crosses another trader's quote between 9:20 a.m. and 9:30 a.m., the market maker is required to send a special SelectNet message stating trade-or-move' to the locked party, offering to trade at least 5,000 shares. The recipient of the message must then trade or move his quote.

As it now stands, Rule 4613(e) simply instructs traders to avoid locking or crossing markets by making a reasonable attempt to trade. Most reportedly do not.

Stocks opening locked or crossed have bedeviled traders with greater frequency in recent times. Traders say it is difficult, if not impossible, to trade a stock when the bid is equal to the offer in a locked market, or is greater than the offer in a crossed market. Many don't bother to trade.

In a normal market, the bid, or the price at which a market maker is willing to buy stock, is lower than the offer, the price at which he is willing to sell stock.

The anomaly occurs when one market maker purposely locks or crosses the quote of another to force him to either update his quote or move out of the way. His goal is to push up the offer or force down the bid to suit his trading strategy. If the second trader does nothing then the market will open locked or crossed.

A trader, for example, might start his day flat or short a particular issue, but will have a large number of buy orders to fill. He presumably believes the market will rise once it opens. If he has guaranteed his customers the opening [offer] price he may try to game' the pre-opening offer higher so he doesn't lose money covering his position in a rising market. Better to push the market higher before, rather than after the open, he would reason.

To game the market, he will enter into the Nasdaq system a bid equal to and an offer higher than the best offer. That locks the market and sends a signal to the locked party to get out of the way. He is supposed to send a SelectNet message indicating a desire to trade, but usually doesn't. Trading is not his intention.

Nasdaq Wholesalers

In most cases, the locker' is a Nasdaq wholesaler with a backlog of retail orders that came in overnight, or a large program trade to execute. One of the largest wholesellers is considered a major locker. The new rule aims to improve the landscape.