NYSE Specialist Practices

Discussion in 'Trading' started by Steve Kellogg, Mar 13, 2001.

  1. NYSE specialist are entrusted to make a fair market. My opinion as a professional trader is that they are significantly more concerned with profiting off you than in offering you a fair price.

    If you have any doubt about the true motives of NYSE specialists, read the March 12, 2001 Wall Street Journal article entiteld "Big Board Specialists Make Money Despite Being an Anachronism." The article highlights exactly how specialist's profit motives can violate the trust we place in them.

    For me personally, my daily experience over the last five years has demonstrated time and again that, despite the value they provide, specialists continuously exhibit exploitive behavior made possible by their ability to determine market prices and their virtually exclusive knowledge of supply and demand.

    The frequency of false bids/offers, orders held for unreasonable timeframes, and general lack of market making are each examples of how specialists ignore their duties. My opinion is that they must be held accountable. Therefore, I provide this forum as a way for all traders, investors, or other interested parties to voice their anger, disgust, and/or other feelings about the specialist system in this forum. Please do so. Perhaps the NYSE will finally wake up to the problem.
  2. mgregor


    Good luck...
  3. I emphatically love the specialist system. It is significantly superior to the OTC system. It is quite obvious that it's manipulated. However, it's quite profitable if you are constantly on the same side as the specialist. This makes trading significantly easier. Rather than watching 20 mm's and ecn's, you just watch the t/s and the specialist. You can pick him off like clockwork. Secondly, as a result of market orders, you know that your order will always be executed almost instantly (unless there is going to be price improvement). I don't have to worry about snets that take 30 seconds, or tier limits, or the 17 second rule. Finally, you can move almost infinite size rather quickly. I trade many illiquid stocks, and even on something that trades under 200k, I can move 5k of stock up or down .2 and usually less. The specialist takes that risk, and in exchange profits off it. The spreads are also significantly smaller. Try moving 5k in under 3 mins on the otc in a stock that trades 200k all day and is 70 a share... trust me you'll have 10k+ in slippage and 15 commission tickets.
    I read the same article as you. But the specialist takes enormous risk. A mm can back away from the inside market at any moment. The specialist has to make a market. He deserves all his profit, especially in the first 15 mins when he chooses where to price the opening print. That example of the ibm specialist that they gave. Those guys took huge risk. They bought a half million shares at a point where the dow was down 400 pts and crashing. Of course they priced it low. They wanted to stimulate buyers. They did. I bought that open in ibm with them. I made 2 pts on 600 shares. I knew they'd open it low (see farrell's opening strategy board here). I wish the nasdaq would go away and be replaced with a specialist market as well honestly.
  4. Steve

    I am with praetorian2

    I rather like the Specialist. It doesn't take too long to learn how to read him. He creates a market when there isn't one. They are held for 2 minutes for a market order. That's pretty impressive when you think about how many orders can come it. Of course the Specialist is in it for a profit. He is taking risk by making a market. I don't know of a Specialist getting paid by the NYSE do you?
    Would you work for free? He shouldn't have to either.

    Your question makes me wonder?? Are you blaming the specialist for your losses? Don't----- you are the one who entered the trade and exited the trade. The only way to learn from mistakes is by admiting you had some blame in the trade. Then you can learn from it. When you have paid your tuition to Wall Street it will no longer school you.


  5. This is the article Steve is referring to...
    March 12, 2001

    Big Board Specialists Make Money
    Despite Being an Anachronism
    By GREG IP
    Staff Reporter of THE WALL STREET JOURNAL

    In a world that dot-coms were about to take over, what could the future hold for a system of stock trading so clunky it relied on human beings? Surely, folks said a couple of years ago, in an electronic age, the "specialists" working the floor of the New York Stock Exchange were dinosaurs.

    Dinosaurs should be so hardy.

    The obscure functionaries who handle the murky tasks of matching buy and sell orders, keeping markets "orderly" and deciding where to "open" a stock are scoring their biggest profits ever. Profit averaged $16 million per partner in just nine months at one specialist firm last year, Spear Leeds & Kellogg. Wall Street giant Goldman Sachs Group, which had decried the NYSE floor system as a barrier to the market's competitiveness, now is rushing to acquire specialists.

    Why the turnabout? Part of it is that electronic networks have failed to reach the critical mass of buyers and sellers needed to be a genuine alternative. But in addition, the specialists themselves have changed. They are increasingly exploiting their unique inside view of the markets to do highly profitable trading with their own money.

    Profits and Grumbling

    This trend has made them robustly profitable. But it also has triggered much grumbling, about a group that has always inspired mixed feelings.

    The main job of specialists, also known as market makers, is simply to match investors' orders to buy stocks with orders to sell them. But what if there are more orders to sell a particular stock than to buy it? Then the specialist firm has to step in with its own money and buy. Or sell, if there's an excess of buy orders.

    But the specialist isn't supposed to buy or sell if doing so would interfere with fair and orderly trading.

    In return for meeting these obligations, the specialist is allowed near-complete knowledge of how much buying pressure and how much selling pressure there is. It's a privilege that any other market participant would die for.

    And it's an easy position to misuse, say the system's critics, who contend that specialists are doing just that more and more in order to fatten their profits. That is what some suggest happened one day last October with Compaq Computer Corp. shares.

    Phil Marber, a trader at Cantor Fitzgerald & Co., placed an order to sell 100,000 shares of Compaq for a big institutional client at no less than $24 a share. Minutes later, Mr. Marber saw a 25,000-share trade in Compaq cross the tape -- at $23.99. He called down to his broker on the floor of the New York Stock Exchange to see what happened.

    Undercut by a Penny

    He was told that a broker who wanted to buy 25,000 shares had entered the crowd, and that the specialist firm handling Compaq stepped in and sold him shares out of the specialist's own account, for one penny less than Cantor's client was willing to sell for.

    Mr. Marber says the specialist figured that with a big seller out there at $24, Compaq stock wasn't about to rally, so dumping it at $23.99 would be a good move.

    But why didn't the specialist simply match the buy order with the Cantor client's sell order? Isn't a specialist supposed to do its own buying or selling only if there is an imbalance of buyers and sellers?

    The specialist was LaBranche & Co. Its chief, Michael LaBranche, says he doesn't know this specific trade or whether his firm in fact sold any of the 25,000 shares. But if it did, he notes, it did the buyer a favor by selling him stock at a slightly lower price than he would otherwise get. He also says $23.99 might have better reflected supply and demand for Compaq at that moment than $24.

    Critics call what LaBranche did "stepping in front" or "penny jumping," and think it's an abuse even though within the rules. "Specialists' attention to their own profit and loss risks eroding confidence in what has been a great marketplace," says Kenneth Sheinberg, head of listed-stock trading at S.G. Cowen.

    But what the critics call stepping in front, specialists call "price improvement." Notes Big Board Chairman Richard Grasso: "You'll talk to people who say penny-skipping is negative. You'll also talk to people who say a penny better is a penny better."

    Whichever it is, it's made easier when stocks trade in tiny increments -- a penny instead of an eighth or a sixteenth -- as all Big Board stocks now do. Specialists say the tiny increments require them to step in more often to keep the market orderly. But even before the NYSE went all-decimal in January, its specialists were doing more buying and selling on their own, known as "principal" trading. NYSE figures show that the portion of Big Board volume in which specialists acted as a buyer or seller, rather than simply a matchmaker, jumped to 27% last year from 18% in 1996.

    As this principal trading has risen, so have specialist firms' profits. They soared to an estimated $708 million last year -- the after-tax total for all NYSE specialist firms -- from $201 million in 1996. Specialists' estimated after-tax return on capital jumped to 26% from 17% in that period, far beyond the 10% or so of the NYSE's brokerage-firm members.

    This comes just a couple of years after the blaze of excitement over electronic networks like OptiMark Technologies Inc., whose anonymous stock-matching system some thought would make the Big Board's floor system obsolete. In 1999, Mr. LaBranche struggled to take his New York-based specialist firm public and "almost didn't get the thing done because people thought the NYSE specialist would be [displaced] by technology," he says. But OptiMark, whose investors included Merrill Lynch & Co., Goldman Sachs and Dow Jones & Co., publisher of The Wall Street Journal and WSJ.com, failed to make inroads on the NYSE and has closed its stock-trading operation. Meanwhile, LaBranche's stock has risen to almost triple its IPO price.

    Big Board specialists traditionally competed against regional stock exchanges and over-the-counter market makers. But in recent years, the biggest threat has come from electronic communications networks, which automatically match buyers with sellers with no specialist or market maker coming in between. ECNs handle a third of Nasdaq trading, and most foreign markets have replaced their floors with ECN-like systems.

    Not Here

    They have failed to make much of a dent in the NYSE's business. With 84% of trading in its stocks taking place on the Big Board floor, the exchange simply remains the easiest place for buyers and sellers to find each other. It's circular: Institutions don't trade Big Board stocks very much on ECNs because ECNs don't have enough orders -- and ECNs don't have enough orders because institutions don't trade on them very much. As a result, while ECNs can charge less and execute faster, there's a risk they won't be able to execute an order at all or only at an inferior price, Mr. LaBranche notes.

    There are subtler factors, too. Some institutions rather like the human factor, the poker-playing feel of dealing in the crowd on the floor. Kevin Cronin, head of domestic-stock trading at AIM Capital Management -- while critical of frequent trading by specialists -- notes that one can ask them for insights into how stocks are trading, but "you can't ask an electronic system questions."

    A specialist also can impose order on a chaotic situation. If suddenly flooded with sell or buy orders the specialist can, under some circumstances, ask that trading be halted until everyone has a chance to absorb the news that caused it. Specialists say they probably wouldn't have let Axcelis Technologies Inc. shares shoot from $10 to as high as $93 because of an investor's typographical error, as happened last month on the Nasdaq Stock Market, where stocks aren't handled by a single person with a full grasp of supply and demand but by ECNs and many different market makers.

    Some Wall Street giants that have invested in ECNs and argued that the NYSE should drop specialists or curtail their role now have muted their rhetoric. Goldman, once the loudest proponent of replacing the whole NYSE floor with an electronic network, spent $6.5 billion last year to buy Spear Leeds. Though the specialist business was less of an attraction than Spear Leeds's Nasdaq, options and trade-processing businesses, Goldman has since agreed to buy another specialist firm, Benjamin Jacobson & Sons.

    FleetBoston Financial Corp., which already owned a specialist firm, acquired another one late last year. And Bear Stearns Cos., also already in the business, has just moved to buy another specialist firm with its partner, Hunter Partners LLC.

    Squeezing Together

    These deals cap a consolidation wave and a culture shift. The specialist system dates back to the late 1800s, when floor brokers began leaving orders with other brokers who would specialize in a particular stock. Legend has it that the first specialist was a member with a broken leg who planted himself at one spot on the floor, according to the NYSE's illustrated history of its first 200 years.

    Fifteen years ago there were still 54 specialist firms, mostly small family-run firms getting at least half of their profits from commissions for matching buyers and sellers. Since then, specialist commissions on some orders have been eliminated as the Big Board has tried to remain competitive. And when the latest mergers close, nine-tenths of the Big Board's volume will be controlled by just five specialist firms, which will typically obtain some 80% of their profits from their own buying and selling of stocks. The five are LaBranche, the Spear Leeds unit of Goldman, the Fleet Meehan Specialist unit of FleetBoston, a firm to be known as Wagner Stott Bear Specialists, and Dutch-owned Van der Moolen Specialists USA.

    Specialists' principal trading, as opposed to mere order-matching, has always been controversial. The Securities and Exchange Commission considered trying to ban it in the 1930s but gave up in the face of fierce NYSE resistance, writes market historian Robert Sobel.

    Criticism of specialists sometimes is no more than routine Wall Street griping when one party isn't happy with how a trade turned out. Part of it just reflects growing competition between "downstairs" specialists and "upstairs" Wall Street traders.

    While complaints are nothing new, they appear to be more frequent. Recently, the NYSE has stepped up its discipline of specialist firms. After disciplining such firms only 13 times in the 10 years through 1998, it has sanctioned specialists 14 times in the past two years for failing in some way to carry out their obligations to maintain fair and orderly markets.

    Those obligations carry risks, because a specialist may be the only buyer when a stock is headed straight down or the only seller when it's headed straight up. LaBranche frequently had to step in and buy AT&T Corp. and Lucent Technologies Inc. shares as they plunged in the third quarter last year, and it lost millions doing so.

    Among the most controversial incidents are big moves at the open or close of trading. One morning in October, after International Business Machines Corp. had reported weak sales growth, sell orders were pouring in and gloom pervaded the market. Some 50 brokers crowded around the two IBM specialists from Spear Leeds. After half an hour of collecting orders, Spear Leeds's Bryant Yunker Jr. issued a price "indication" a few minutes before the opening bell. He said IBM would probably open at between $95 and $98 a share, far below the prior day's close of $113 but about where the stock was already changing hands on an ECN operated by Instinet Corp.

    But with more sell orders arriving and brokers changing their orders, Mr. Yunker warned that this price indication wouldn't hold, and issued a new one: $92 to $96. Then a broker ran into the crowd yelling to hold the opening -- he had a big block to sell. The indicated range dropped to $90 to $94.

    Finally, at 9:45 a.m., the opening trade hit the tape: four million shares at $90.25, down a whopping $22.75 from the previous day's close. That sliced 135 points from the Dow Jones Industrial Average, of which IBM is a part, widening the DJIA's loss at the time to about 425 points. The market was in freefall.

    Had IBM kept dropping, few would have suffered more than Spear Leeds. With more sellers than buyers around, the specialist had to purchase almost 500,000 shares at the opening, say traders present that morning. But within 10 minutes, IBM was back up to $95, handing Spear Leeds a profit that outsiders estimate at as high as $1 million.

    Grumbling followed swiftly. Since Spear Leeds had opened IBM sharply below where the stock was trading on Instinet (and where it was just 10 minutes later), it appeared the specialist "might have forced [it] down an extra couple of points," says S.G. Cowen's Mr. Sheinberg. The lower price -- which was also the price at which Spear Leeds did its buying -- meant bigger profits for Spear Leeds when the stock rebounded.

    Spear Leeds co-chief Andrew Cader says the opening was a "reasonable representation of what a specialist can and should do on a day when the entire market was falling out of bed." Mr. Sheinberg agrees that second-guessing is easy and managing an opening under such conditions is not.

    Mr. Grasso has steered a middle course amid controversy over specialists, who own or lease a third of the Big Board's seats and hold three of the 24 directors' spots on its board. When ECNs were on the rise in 1999 and the Big Board chairman faced pressure from large firms to adopt screen-based trading, he arranged for a board committee to look at the market's structure. It came back with a report trumpeting the importance of the specialist, especially in "moderating the severity of market volatility." Mr. Grasso also began a pilot program that lets investors bypass specialists with small orders. But he maintains specialists' trading has been "enormously positive" to the Big Board's customers and he has shown no inclination to materially reduce their role on the NYSE.

    It's fine with Mr. Cronin of AIM Capital, who likes "a centralized marketplace where we can find buyers and sellers and can find anonymity on the floor." But Mr. Cronin adds: "If specialists continue this egregious behavior of stepping in front, blocking trades and dislocating openings . . . , maybe the things people have predicted for so long about the system will come to fruition."

  6. Slightly off topic

    but this is an article from the "Wall Street Journal" as a trader I don't follow them. They are the public and are always on the wrong side of the market. It's well known to fade them on the floor. I prefer IBD
  7. holtf


    rtharp. Are you suggesting that profit is an excuse for a specialist to shirk his market making duties? Smell the coffee pal. Just because a used car saleman shouldn't "work for free" doesn't mean he should be able to trick a customer into paying $30,000 for a 79 Pinto.

    Specialists are all powerful. The question is, do specialists abuse that power. You'd find innumerous profitable NYSE traders that would answer a resounding yes to this question.

    There are many upstanding specialists, but there are also many bad apples. Whiplash prints, held orders, and deceptive spreads are exceedingly common with NYSE stocks--even large caps. Who are you going to blame for this tharp? The trader--for choosing to trade on the NYSE?

    Enforcement of specialist guidelines needs to improve. That is step number one. If things don't improve, specialist are going to be shoveling horse shi_ in 2-3 years instead of fleecing traders.
  8. Specialists have a monopoly on the most critical information and yet are allowed to trade for their own accounts in the name of keeping an "orderly" market in their stock. It's not too difficult to see the conflict of interest inherent in this system.

    Someone stated that specialists should be able to profit because they take risks. Since when did taking a risk entitle anyone to make extraordinary profits unfettered?

    And it's debatable how much risk the specialists are actually taking. I participate in the markets everyday and accept the risk of losing on any given trade and over any given period, and yes, even the risk of blowing my entire account and going out of business. I know traders who have been taken out of the game because of the risks. I don't know of any specialist firm that has gone out of business.

    The primary argument I've read here by those in favor of the specialist system is that these traders can make money by reading the specialists. That rings a bit hollow. The fact that one can make money says nothing about the system's efficiency or fairness.

    People decry the payment for overflow by the Nasdaq market makers. Why shouldn't we view the specialists with the same suspicion?
  9. I still think they execuate a fair market. Yes, some hold prints, and yes they manipulate. But what's the matter with manipulating a market. As long as they are liable for any order comming in while they try to move the market, then it's still a fair market. Lots of hedge funds accumulate shares to sell after moving. I quite often take really illiquid stocks (under 200k a day) and break them out over obvious congestion once I have a 3-5k position. On the nasdaq, a few large snet broadcasts strategically placed will do this. THen I sell those shares out 1-3 pts higher as everyone chases the breakout. What's the matter with that? I take the risk that someone fills my 5k snet broadcast. I take the risk that a seller comes in. I take the risk that no traders see the breakout and enter. It's the same concept. A specialist who knows that there are no sellers around, and a good stack of bids has every right to accumulate 200k shares just above those bids, and then run the stock up 3 pts, and hope that one of those buyers upps his bid so he can take the 600k profit. Its very obvious also what the specialist is doing. If you know what to look for, you'll see it too and play along with him.
    Granted, some specialists hold orders for longer than is necessary, but in fast conditions, that's justified b/c it's all done manually. You also now have instant access with island. Cross his quotes, and someone will try to take the arb opp. I rarely wait more than 25 secs though to get an execution on market. There is no reason not to use market. Now that I know how to time my exits, I almost always get at least .3-.6 price improvement on my market orders.
    Finally, if you don't think that specialists offer a fair market, try to sell 5k of krem in 3 minutes tomorrow during the first 20 minutes. Then wait a week and do it when it is on the nyse (KK) it'll be done in 20 seconds. You'll be filled on the bid, and all in 1-3 prints. On the otc, you'll be running up tickets as you try and snet the mm's 200 at a time.
  10. praetorian2 nice post again.........

    Well I'm fine with the system

    If I could actually find a buyer for $30,000 for a 79 Pinto you'd better believe I'd sell it to him or at least grab a finder's fee for the seller. Who here on this board wouldn't? I trade for profit.

    Yeah sometimes the specialist manipulate the market? You don't think that happens elsewhere? Look at EMLX when it posted it's first real negative news? a 50% drop in 5 minutes isn't manipulation? Market Makers dropped that puppy like a rock because they had to buy it from the public. They knew the risk involved. When the public stopped selling they brought it up and dumped it.

    I get a lot better fills on NYSE/AMEX than I do on the NASDAQ. It's not as volatile either and you know why? The specialist keeps the market orderly. Very few NYSE stocks rose 50% in a day for days at a time. That was manipulation at it's finest. The market makers and mutual funds were selling to the public. When the buying stopped the market tanked. The market makers could then cover for a profit. They took risk by taking the other side of the spread. I feel it's a fair system.

    How about QCOM going up 150 points in a day? That isn't manipulation? Market makers sold completely into that frenzy......and profited nicely in a few days to come.

    NYSE doesn't do that because the specialist holds the market to levels more in the norm. That is holding risk in itself. How does he know that more buyers/sellers won't be coming in soon? Yeah he has his book but he can't read the mind of the entire world who might be watching him.

    Hey you as the public even get to go first. If you place a limit order above the specialist he has to let you go ahead of him because you are a customer. He can outbid you(an it's easier now that we trade in pennies) or let it go. The spreads are smaller now and not much depth which shows it isn't the specialist on the bid /ask anymore. I like having depth. It's nice to know I can enter an order for 30,000 shares and get filled by a few ticks in a liquid stock. I can't do that on NASDAQ all at once. I can easily move the market with some size in NASDAQ for a short time frame but once I stop it will be returned to normal.

    NASDAQ isn't based that way so it's only first come first served. There is one less advantage.

    There are two sides to the coin.

    If you don't like the system don't trade it. NASDAQ is open market feel free to only use them.

    I know this isn't a forum for talking about stocks but..
    If you feel they have such an unfair advantage and it bothers you this much all I can say is LAB. Take a look at the fundamentals of the stock. It's a group of specialists pooling their money together that trades on the NYSE. You can profit with them if you want.

    The opening price to my knowledge isn't set by the specialist but by a computer. It's done automatically taking into account all of the orders for buying and selling. The computer figures out the price the Highest # of orders will be filled. That's the opening price.
    #10     Mar 15, 2001