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...heard of payment for order flow, right?" Madoff asked. "Huh?" I responded. Madoff explained that Bernard L. Madoff Investment Securities had pioneered the practice of paying customers to trade through it, thereby siphoning business away from the New York Stock Exchange (NYSE). The firm was able to use its sophisticated computer systems and trading algorithms to earn enough off the spreads between what it bought and sold stocks for to more than offset the amount it paid customers. (See the top 10 crooked CEOs...
Since 2007, the evolution has accelerated. Less than a third of the trading in NYSE-listed stocks is now done through the NYSE - and only a tiny fraction of that by the floor traders, who now function mainly as a colorful backdrop for CNBC broadcasts. Virtually all stock-trading is electronic, and somewhere from 45% to 70% of trading volume is done by high-frequency traders who make their money by the millisecond...
...become controversial. Flash orders - a feature offered by some exchanges that allows high-volume traders the advantage of posting orders for up to half a second and then removing them - have drawn the ire of the authorities. Related revelations about the high-speed, almost fully computerized nature of modern stock markets have occasioned no small amount of fear and loathing. (See pictures of a Madoff family album...
...fear may be justified, the loathing less so. Stock-trading in the U.S. was long dominated by a cartel (the NYSE) that charged exorbitant fees and stifled competition. That cozy arrangement began to fall apart in the early 1970s with the birth of the Nasdaq electronic exchange for small stocks. The rapid growth of Nasdaq companies like Intel and Microsoft, coupled with Madoff's poaching of orders from the NYSE in the 1980s and '90s, brought more direct competition. Now things have broken wide open. Nasdaq and the NYSE are still the biggest players, but they must do daily battle...
...frequency trading firms you've never heard of - GETCO, founded a whopping 10 years ago, is the granddaddy - that try to get ahead of millisecond-by-millisecond price movements and take advantage of rebates paid by exchanges to those who create liquidity (that is, offer to buy or sell stock at a certain price and assume the market risk). Not surprisingly, the exchanges cater to these firms - with flash orders and "co-location" arrangements that put traders' computers right next to their own, giving the firms a profitable millisecond-or-so edge in trade execution...