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August 1, 2011

Summer Reading

By Michael Scotti

This month four years ago was a significant time. It was in August 2007 when the financial crisis began. That was the beginning of the unraveling, as quantitative investors took a shellacking in the market. Suddenly, once profitable investment strategies went haywire, producing huge losses. Wall Street Journal reporter Scott Patterson depicts the August rout and the evolution of quantitative investing in his fascinating book "The Quants." This month's cover story is part of that tale, Wall Street's move to computer trading. Our story, however, is approached more from a market structure angle. Rules and market structure go hand in hand. And since the SEC put into effect its market access rule that banned so-called "naked access," the bulge bracket brokers have been courting this business.

Michael Scotti

You can read about the bulge bracket's strategy and views in James Armstrong's piece this month, "Up For Grabs." All the trading venues want high-frequency trading flow-from the exchanges to the dark pools. Big brokers have internalization engines, or their own crossing networks. These are used to give investors executions at the midpoint, but also to avoid exchange fees. We've got brokers and dark pools on one side of the equation and exchanges on the other. It's a strange symbiotic relationship they have. They need each other-just as they both need high-frequency traders to make their venues work.


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Our Rules and Regs section features two stories related to this month's cover story. (Isn't everything related to high-frequency trading these days?) Both are written by Peter Chapman, our regulatory and market structure editor. First, there's a story on the ban on so-called "naked access." The rule has two aspects. Regulations on risk checks, including erroneous trades, went into effect in July. But the trick for the industry will be complying with the second leg of the rule, which goes into effect Nov. 30. That's when credit checks will be required for each client. The story outlines some of the issues the industry faces in complying with that second deadline.

Our other regulatory story covers limit up/limit down, which puts price bands on orders. The goal, of course, is to avoid another "flash crash." With a limit up/limit down rule, market orders wouldn't chase ridiculous prices and execute. Yes, the industry is generally in favor of these bands. But different groups have some concerns with the rule. Peter's piece is as good an account as you'll find anywhere on this topic. I hope you enjoy the issue and the rest of the summer.