The ticker tape defined the market boom of the 1920s. The back room defined deal making in the 1980s. The defining image of today's boom in day trading is The Island.
"It's a matching board," explains analyst Matt Stamski of Gomez Advisors. "Orders are matched internally with no spread." That means that when a buyer's bid and a seller's ask price match, trades execute automatically, for $1 each. The nearest offers are listed on traders' screens.
The Island's grandfather is NASDAQ's Small Order Execution System (SOES), created in 1985 to service small trades. After the 1987 market collapse, when many small traders were stampeded and found they could not complete trades on SOES, the Securities and Exchange Commission (SEC) required major brokers to participate fully in SOES to improve the system's liquidity.
Of course, small is in the eye of the beholder. Disturbed that "SOES bandits" were taking away brokers' spreads -- the profit they make on the difference between "bid" and "ask" prices in trades -- the National Association of Securities Dealers (NASD), which runs the NASDAQ stock market, fought to limit the impact of SOES, explains Chris Wheeler, president of DayTradingStocks.com, an information site serving day traders.
In 1995, a court ruled in the case of Timparino vs. SEC that NASD rules were unfair. New SEC rules were issued in August 1996, and NASDAQ finally changed its rules regarding SOES strengthening the system by increasing the number of shares available through SOES trading and the size of allowable trades.
Meanwhile, SOES trader Jeffrey Citron, now chairman of Datek Online, was working with computer programmer Josh Levine on the tools side. Levine's initial Island program ran under the old MS-DOS operating system, but it "evolved," in his words, into an Electronic Communication Network (ECN) that could automatically match bid and asked prices for all brokers, including those running day-trading rooms.
NASDAQ now maintains a list of ECNs at its Web site. By February 1998, ECNs were executing 22 percent of NASDAQ trades, and the Island had 20 percent of the market. MBTrader, which produces software used by day traders, offers a fine tutorial on ECNs. (The software used at Capital Gains is CyberTrader.)
The ECN market continues to evolve rapidly. Last December, the Island asked to become a stock exchange in its own right. An ECN called NexTrade said recently it wants to keep its trades private. On Jan. 7, 1999, ETrade and Goldman Sachs each bought 25 percent of an ECN called Archipelago.
SOES trading and ECNs give a mass-market purpose to NASDAQ Level II screens, which detail the actions of market makers. Combining these resources into a complete trading system required only programming and networking. A new industry was born.
Josh Levine, by the way, is still a player in that industry. His Watcher program automates the process by which traders can place and get executions on Island orders. He gives the program away to traders, and trading firms, taking a fee (he won't say exactly how much) on each trade executed with it.