Alternate Stock Markets Serve Institutions
In both Canada and the US there are multiple alternate stock markets set up to exchange shares for institutions. Alternate stock markets set up as direct competitors to the major exchanges. They serve institutional traders or to profit their institutional owners. Generally speaking, these businesses compete with the major exchanges that we discussed in recent blog posts.
This post is Part 9 of the White Top View Series, Stock Markets, basic discussions of the American and Canadian stock markets. Links to all parts of the series are at the end of this post.
Of course alternate stock markets are all about making money. Typically alternate markets are digital exchanges owned by dealers or brokerage houses. More recently multiple bank groups see the money-making possibilities and got involved. There are three basic goals for these alternate exchange markets.
Alternate Market Goals:
Avoid exchange fees
Capture more profit
Press for lower fees
To do this they route many client trades to an exchange system they own. Trades that go through their system avoid paying fees to an outside company or exchange. That puts the established exchanges under pressure to lower fees to keep the trades. Either way the bank wins as owner of both the dealer and exchange.
This is an example of a business being created at relatively low-cost around digital technology. The relatively low setup and operating cost of a digital exchange can greatly benefit dealers associated with exchange ownership. They collect a larger part of the fee paid by the trading client or use the competitive pressure to force lower fees on the outside exchange.
The TSX and TSX Venture Exchanges in Canada as well as the NYSE and NASDAQ in America are all affected and under pressure to lower fees. That may keep fees down for the big trading houses but it does nothing for us. The fee pressure does not give retail clients a cost break.
As retail clients, we pay the same amount of fees as before. From our point of view the fees all go to our dealer. However, dealers pay part those fees to the exchanges.
Dealers owning an exchange effectively move the money from one pocket to another. That means a larger slice of the total we pay can stay in the accounts of the dealer or their holding company. In Canada most big banks own parts of alternate exchanges.
For clarity, this is a simplified explanation that glosses over and avoids many facts, nuances and details. That makes it a very superficial explanation. Still, the overall net effect remains. Banks, dealers or brokers have another way to serve you and help themselves to more of the fees you already pay to trade.
Think of it like multiple bus companies traveling the same route. You get to take the most convenient and comfortable ride. From your point of view, they all cost the same. So you simply take the next one that comes along. For the return trip you can take the same or any other bus without knowing or being concerned about who owns it. We still get where we want to go. The bus owned by the bank simply keeps more of our costs in their account and not having to pay for a ride on a bus owned by another company.
Being aware that there are alternate markets is what you need to know. Regulations require dealers to route orders to the most favorable fill. That means all exchanges and dealers, at least in theory have an equal opportunity to see and fill any order. In theory, you still get the most favorable price.
That series opens with the CBS News program 60 Minutes presentation, Is the U.S. stock market rigged? That excellent program exposed the market rigging of High Frequency Trading and put this topic on the public agenda. As the series on high frequency trading does discuss, you and your fortune are indeed affected, even if you are not directly in the market.
What do alternative markets mean to you? In a practical day-to-day terms, nothing. It is an aspect of investing today that you now know exists. So when you hear of alternate exchanges or markets you will know that you are not missing out.
Alternate Markets Affect Volume
Declining share volume on the largely followed public exchanges are a direct effect of alternate market trading. Most retail investors pay little attention to market volumes. But superior investors and the pros do. Technical analysts also depend upon volume are a key metric they subject to much analysis.
Before any significant off-market trading occurred, trades were visible on the open public markets with volumes clearly seen. These were meaningful numbers. Analysing them provided useful indications of market activity and trends.
Once a significant amount share trades moved to the alternate markets, obviously the related volume also moved from the traditional established market. The volume did not disappear, it simply transactions you and I can’t see.
Dark pools or rooms, upstairs markets, off-market trading and any number of other euphemisms get used to describe alternate markets and hidden trading sites. Alternate markets, in effect, hide the volumes they trade. The volume remains in the total market, we just don’t get see it or track it.
That means we can no longer depend on any volume based analysis to give reliable and useful information about market activity. There has been much hand wringing by pundits over the declining reported volumes, but it is not hard to see where much of it has “disappeared”. The volume has simply moved from the former market to an alternate market.
What does that mean to you? Not much. Just be aware the long used volume measures of stock market activity have also changed. Be careful who and what analysis you listen to. When making your investment decisions, be cautious of considering opinions expressing alarm over a market measure or outlook that you know has changed.
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These discussions and information intend to help you better understand markets and investing. I am not a financial or investment advisor; opinions are for informational and educational purposes only and are not intended as investment advice. For syndication of the site or blog, please contact info@WhiteTopInvestor.com.
Images courtesy FreeDigitalPhotos.net
Images courtesy FreeDigitalPhotos.net
Links to the White Top View Series, Stock Markets