TCS Daily


Wall Street's Endangered Species

By Dominic Basulto - April 26, 2005 12:00 AM

The New York Stock Exchange's sudden decision to merge with electronic trading system Archipelago, coupled with a similar announcement only days later by Nasdaq that it would acquire Instinet's electronic trading market, means that the Wall Street floor trader is now as close as it ever has been to being an endangered species. In fact, the floor trader could be extinct by the year 2010: according to an informal Wall Street Journal Online survey conducted immediately after news of the NYSE-Archipelago merger broke, a majority of readers expected that the position of the Wall Street floor trader would no longer exist within five years. When that happens, the trading floor of the NYSE -- one of the last remaining places in the world where men wearing peculiar jackets wave pieces of paper in the air, run around frantically between the ringing of bells, and shout out orders into a delirious bedlam of money-making -- will become nothing more than a museum floor for 21st century capitalism, a quaint historical anachronism that failed to keep up with rapidly-changing technology and the needs of market participants.

The open-outcry auction method at the NYSE, which relies on human floor traders to make efficient, orderly markets in listed stocks, was simply no match for the efficiency, transparency, liquidity, and instantaneous market execution of electronic trading. The merger of the NYSE-Archipelago shows that a truly disruptive technology is an unstoppable force, even when confronted with bureaucratic inertia and regulatory roadblocks. Electronic trading, by eliminating the need for human intermediaries to gather in a centralized location, has dragged the New York Stock Exchange into the modern age, kicking and screaming. While the NYSE wrapped itself in the glory of a 213-year tradition, nearly every other market in the world has already adapted to electronic trading. Equity and derivative exchanges in London, continental Europe, Tokyo, Hong Kong and Sydney have embraced electronic trading for years. Even the Chicago Board of Trade -- one of the most fervent supporters of the open-outcry model, has finally acquiesced to the logic of electronic trading systems.

To be sure, the NYSE and the open-outcry model are not going down without a fight. NYSE Chief Executive John Thain has pitched the merger as a "hybrid" creation in which floor traders will handle the majority of trades, with electronic exchanges handling any spillover in trading volume. It will slowly phase out the floor traders while it modernizes in order to catch up with other exchanges that offer electronic trading. For example, the NYSE will now be able to trade listed stocks in other markets, as well as other financial instruments, like exchange-traded funds, options and assorted other derivatives. Keep in mind, though, that the NYSE will do everything possible to avoid doing away with the floor entirely.

As Harvard Business School's Clayton Christensen noted in "The Innovator's Dilemma," entrenched market competitors who at first ignored the appearance of a disruptive technology are often forced to scramble in order to preserve their market dominance. By then, though, it is often too late: their only option is to co-opt competitors by using any regulatory means at their disposal. If that doesn't work, they will attempt to buy their competitors outright. In the case of Wall Street, this is exactly what happened. Whether it was the debate over decimalization (which threatened to erode the profitability of each trade) or the debate over the "trade-through" rule (which threatened to siphon off trading volume to other exchanges), the NYSE was at the forefront of efforts to maintain the status quo and preserve the turf of its specialist traders.

Make no mistake about it, investors are better served by electronic trading and the new breed of electronic trading networks and, for that reason, efforts to save the Wall Street floor trader are ultimately doomed to failure. It is now clear that electronic trading offers the anonymity, speed and transparency required by modern financial markets. Electronic networks enable more efficient matching of buyers and sellers, instantaneous access to market liquidity and the elimination of potential conflicts and errors among specialists on the trading floor. Consider that modern electronic limit order books can match trades in milliseconds, while the floor traders measure their execution time in tens of seconds. Moreover, all-electronic markets do not need to pay for all the expensive overhead of the open-outcry model, like floor traders, clerks and assistants - some of whom, it turns out, are prone to trading improprieties and other errors of judgment.

As more than one observer has pointed out, the frenzied shouts and jostling of sweaty bodies in the trading pits are certainly more entertaining than the electronic blips of a computer trading screen. Don't worry, though, the floor of the NYSE will still be a must-see tourism destination in New York even five years from now -- but for a different reason: it will now be the final resting home of capitalism's latest breed of endangered species: the Wall Street floor trader.

Dominic Basulto is a TCS contributor. He writes frequently about finance, venture capital and technology.

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