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October 19, 2006

Philly Stock Exchange Plans to Allow Directed Flow

By Peter Chapman

The Philadelphia Stock Exchange has plans to encourage market making on its new trading platform by offering dealers exclusive rights to capture their customers' orders.

"In the future, we want to expand the basic market maker functionality to allow market makers to perform additional services for their customers," says Bob Miller, a senior advisor to the exchange.

"One way to do that is to let market makers offer a directed order flow service and, with it, the opportunity for price improvement," he says.

While the practice of "directed order flow" is typically associated with the over-the-counter market, it has been permitted in the past by some stock exchanges.

It gives a specialist or market maker exclusive rights to receive orders from its customers so that it might provide certain price and size services.

Under the Philly's plan, orders would be sent either directly to a particular dealer or to the exchange first, where they would be exposed on the public book. The exchange has not yet decided on a methodology, according to Miller.

Typically, exchange dealers prefer the order to come to them directly rather than run the risk it will get broken up in the marketplace.

The Philly filed its plan to form a purely electronic stock exchange with the Securities and Exchange Commission in July. Under the plan, market makers would be required to post two-sided orders (not quotes) on a continuous basis.

At presstime, the SEC had not yet approved the plan.