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February 24, 2006

You Never Know

By Michael Scotti

Michael Scotti, Editorial Director

Hype or reality? That's what the brain trust' of this publication was wondering when it recently sent out a spot survey on electronic trading to a selected group of 1,500 buyside readers. The results were surprising to us at first: 51 percent of respondents said they would only "slightly increase" their electronic trading in 2006; 36 percent said they were satisfied where they stood and expected no increase.

The outliers-13 percent-were almost evenly split between expecting to "dramatically increase" and expecting to "decrease" their electronic trading.

You can read about the survey in greater detail in this month's "Trading Insights" section. We were pleased and a little surprised that the consultants and industry experts were in agreement with the accuracy of our findings. Folks, electronic trading is maturing.

Still, with Reg NMS on the horizon and less friction expected in the markets, many predict there will be a major upturn in electronic trading. But just because total equity trading volume increases, that doesn't necessarily mean that the traditional buyside will change its trading style. Stat arbs and other quantitative traders are projected to be the main drivers in this expected surge in trading volumes.

At some point, the manual trading at traditional institutions could give way to electronics. For example, suppose the buyside "slightly increases" its level of electronic trading each year for the next five or 10 years? That would result in significant erosion of the traditional method of phone-based trading.

In fact, Goldman Sachs believes that, at some point, 80 percent of equity trading will be electronic with average commission rates of 1.5 cents. That's how it is gearing up its trading operations. Goldman may be 100 percent correct. The problem is we just don't know when. I recall in 2000 when Nasdaq was hyping its SuperMontage platform, and a well-respected analyst predicted it would garner 75 percent of the Nasdaq Market.

Well, that's about what eventually occurred. But it took the recent merger of Nasdaq and Inet-and a few others before it-to make that prediction come true. Who could have predicted exactly how that would have happened? You never know what you don't know.

There are plenty of variables in any prediction. The same logic applies to electronic trading.

In the meantime, with the recent volatility in the markets, there has been a greater reliance on upstairs traders. And there have been anecdotal reports about a resurgence-or at least a greater willingness by the buyside-to trade in blocks. Traders are smart. Whether it's electronic trading or phone-based trading, they'll do what's best for their investors.

Michael Scotti,

Editorial Director