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In this piece from 10th Man, author Jared Dillian discusses how the ETF revolution is less about ETFs and more about indexing; about how people have come to view stocks less as stocks and more as blobs of stocks.

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July 15, 2007

Same Problem, Different Solution

By Nina Mehta

One of the problems traders face when they drop an order into a dark pool is missing fills in the broader marketplace. BIDS is trying to solve the problem with conditional orders that enable traders to sit in BIDS and still execute elsewhere.

Pipeline Trading Systems has come up with a different solution to the same problem. The operator of the dark pool has developed a piece of software that allows a customer to execute a large order partly in the displayed markets-through the trading algorithms of about a dozen brokers-and partly through its Block Board crossing platform.

"We harness the best algorithms that are good at hiding orders and preventing orders from being picked off," says Fred Federspiel, Pipeline's chief executive.

Pipeline's "algorithm switching engine" uses technology to identify how market conditions are likely to change over the next few minutes. The engine then selects the sellside algo with the best expected performance results for those conditions, switching between algorithms as necessary.

Customers cannot select which brokers' algos they want the engine to use. Broker-dealers will be paid a per-share execution fee by Pipeline for the use of their algos. Pipeline's customers, in turn, will pay Pipeline 2 cents per share for executions through the algo switching engine and Pipeline's Block Board.

Since Pipeline is likely to be charging more for the use of these broker algos than buyside firms might pay if they accessed them directly, the product must prove its mettle to gain traction, observers note. It must significantly improve buysiders' workflow by enabling large orders to get done efficiently and with minimal market impact, and it must improve the execution results over what the buyside desk might have achieved on its own.

Customers decide how much of an order to put in the engine when they access Pipeline. As that piece of the order is executed algorithmically, the engine feeds more of the larger order into the algo. Federspiel says the engine will funnel volume into the algo without seeking to maintain enough shares on Pipeline's crossing platform to qualify for the minimum block size.