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April 1, 2002

The Winds of Change: How internalization changed the course of history for a Midwest dealer.

By Peter Chapman

Finally, its alliance with E*Trade has taken it to markets overseas. In February, E*Trade snapped up a team of traders from Nomura International in London. The group will form the core of a new U.K. market making operation to be overseen by Dempsey.

All told, Dempsey now trades in five market centers: London, the CHX, the BSE, Nasdaq and the Bulletin Board marketplace. It trades 700 listed stocks at the CHX and the BSE; 150 Nasdaq stocks at the CHX; a comparable amount of Nasdaq stocks at GVR; and about 1,500 bullies at GVR.

Klobuchar is not satisfied though. "We don't intend to stop with just those market centers," he said. "There could be some important opportunities in a few of the others - perhaps other regional exchanges."

Further expansion, however, is no longer predicated on the need to pick up new stocks. What Dempsey wants is flexibility. It wants to be able to trade in the most competitive locale. "Once you reach a certain size it's awfully important not to put all of your eggs in one basket," Klobuchar said. "The capabilities of market centers are an important competitive issue."

Key selling points for Klobuchar are better and more robust trading systems; greater capacity; efficient operations and low transaction costs.

So, is the trading house walking away from the CHX, its home since 1954? "Not at all," Klobuchar said. "We haven't pulled a single stock off the Chicago. We're just growing. Those guys are doing a splendid job."

And despite the trend towards internalization, Dempsey clearly has growth on its mind. The firm's affiliation with E*Trade was not entirely a defensive maneuver. Klobuchar cited three non-traditional order flow possibilities with E*Trade: institutional, international, and options.

Buyside Desks

E*Trade services 650 institutional customers worldwide. That is expected to ease Dempsey's entrance into the block business. Dempsey is traditionally a retail shop, but has started to make its presence felt on buyside desks by advertising on AutEx. The move is not without precedent. Knight Trading Group, for example, has, in recent years, successfully leveraged its role as small-order aggregator to win block trades.

"If we can't be the first," Klobuchar said. "We don't mind being a well-implemented second. And remember, Knight started from scratch whereas E*Trade has hundreds of customers."

E*Trade is keen on offering its buyside customers market making services. "With Dempsey we have this great liquidity pool," said Jarrett Lilien, E*Trade's chief brokerage officer and Klobuchar's boss. "But, to date, all we offer our institutional clients is an agency execution."

E*Trade got into the institutional business in 1999 when it purchased the international agency brokerage TIR Securities. Lilien was CEO of TIR.

But do E*Trade's institutional clients want it to be a market maker? Typically, a buyside shop executes through an agency broker because it will not trade against its orders.

"That's a fair point," Lilien said. "We will let our customers choose between agency brokerage and principal brokerage. They can choose the type of execution they want."