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February 2, 2006

This is the Year of Pre-Trade Advances and Market Structure Changes

By Michael Scotti

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  • This is the Year of Pre-Trade Advances and Market Structure Changes
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Morgan Stanley's Brian Fagen has a unique perspective on electronic trading, having spent the bulk of his 18 years in the securities industry in program trading. He heads Morgan Stanley's client self-trading group-which includes direct market access, algorithms and Morgan Stanley's Passport DMA system. The self-trading group grew out of Morgan Stanley's program trading desk. The broker decided to separate the two in 2002. "We split program trading and electronic trading because we believe there is an anonymity factor in using self-trading tools," Fagen said.

The development of these products, Fagen said, took place in MSCO's financial engineering group. The department looks at issues like managing risk and market econometrics, as well as market structure. Fagen works with this group to find ways for

Morgan Stanley to trade more efficiently across all its business lines. The ultimate goal is also to try to develop new products for clients. Fagen said all MSCO's trading desks in cash equities and derivatives have the same algorithms as MSCO's clients.

Traders Magazine Editor Michael Scotti met with Fagen to hear his thoughts on a number of hot-button topics being discussed within the industry.

On the NYSE Volume Shift...

The NYSE's market share, which had been 80 percent or more, recently slipped to below 75 percent. On the decrease in the NYSE's market share, Fagen said he believes the competing electronic venues are beginning to develop critical mass.

"Volume is not moving off consciously," explained Fagen. "It's moving off the NYSE because these stocks are hitting their tipping points." Essentially, orders are no longer at a disadvantage when being sent away from the New York. The fear of missing volume and trading at inferior prices has lessened in the most liquid stocks, he said.

"The percentage that a stock trades on the New York is highly correlated to its overall volume," Fagen said, adding this axiom: "The more liquid the stock, the less likely it is to trade on the New York."

On Reg NMS...

Many industry observers believe that NYSE-listed volume will double as a result of Reg NMS, an SEC rule that will restructure the equity markets by increasing competition across market centers. Fagen agrees with those who predict a doubling of volume for listed stocks. Consequently, there logically would be an increase in algorithmic trading if electronic trading volume overall also increases, he said.

Fragmentation will be created by the various exchanges competing for best price. Because algorithms excel at managing the distribution of liquidity across market centers, he said, there likely would be a greater need for them.

Algorithms will also need to adapt to Reg NMS, he said. That's because the routing patterns and the rules for orders will be different under Reg NMS, he said.

On the Regionals...