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The High Frequency Game Changer: How Automated Trading Strategies Have Revolutionized the Markets by Sang Lee, Paul Zubulake

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Chapter 2

Market Structure

Upheaval and uncertainty are two words that can be used to describe the current status of the U.S. equities market. The hostile institutional trading environment continues as shrinking commission rates and spreads have driven many experienced equities traders out of business altogether. Electronic trading has established itself as the main mode of trading, but uncertainties abound that are driven by regulations and the evolution of sophisticated trading strategies and technologies.

The adoption of Regulation National Market System (Reg NMS) in 2005 institutionalized the legitimacy of electronic trading and has forced all of the major exchanges to launch trading platforms with automated execution capability to remain competitive in the post-Reg NMS market structure. Reg NMS has also ushered in a wave of market consolidation as NASDAQ and the New York Stock Exchange (NYSE) sought to solidify their competitive positions: NASDAQ acquired INET, a leading electronic communication network (ECN), and the NYSE linked up with ArcaEx, a leading all-electronic regional exchange (and a former ECN) to create what appeared to be a de facto duopoly in the U.S. equities market.

However, this trend of consolidation was short-lived. Soon after the announcements of the NYSE and NASDAQ combinations, numerous ATSs (alternative trading systems) and ECNs emerged, sensing new market opportunities in the post-Reg NMS environment. As a result, market fragmentation has occurred ...

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