Abstract
In the United States, the same stock can be traded at different locations. In the case of listed stocks, each location is a node in national network called the Intermarket Trading System (ITS). Unlisted stocks also trade at different nodes on the National Association of Securities Dealers Automated Quotation (NASDAQ) network. Each node of these two networks may have rules for breaking queuing ties among competing orders. Orders may be routed on the networks according to official rules (as with ITS) or order preferencing arrangements (both networks). This chapter examines the impact of priority rules on individual markets and networks. The development of the ITS and NASDAQ networks as well as the relevant literature is discussed. I conclude that network priority rules improve market quality if they result in consolidated markets.
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Notes
- 1.
See Domowitz (1993) for taxonomy of many of the different rules found in different markets.
- 2.
The following list is taken from an unpublished paper I co-authored with James Angel entitled “Priority Rules.”
- 3.
For example, on the old TSE CATS system, time priority did not expire, while on the Amex time priority lasts only until the next trade.
- 4.
Note that size priority is different than pro rata sharing in that an entire incoming order may go to a single trader as opposed to be shared.
- 5.
Tick size is the minimum price increment.
- 6.
Assume a $0.125 tick size. Then in order to step ahead of an existing buy order, a trader must be willing to pay $12.50 more for each 100 shares he obtains. If the tick is only $0.01 then that same trader must only pay $1.00 more for each 100 shares he obtains.
- 7.
Exchange Act Release No. 14416 at 4358.
- 8.
A specialist is the designated primary dealer on a stock exchange. They have complete knowledge of all investor orders and generally have obligations to maintain orderly markets.
- 9.
NASDAQ will be discussed in the next section.
- 10.
Limit orders are orders to buy or sell a security at a specified price or better. Public customers submit limit orders, specialists and NASDAQ market makers submit quotes.
- 11.
The quotes are predominately based on public orders. As evidence of this, consider that during 2003, NYSE specialists were involved in less than 20% of all trades.
- 12.
The NASDAQ trade, through rule, only applied to an individual broker. That is, Broker X was not allowed to trade through any customer of Broker X, but was not prevented from trading through customer limit orders held by Broker Y.
- 13.
The Midwest Stock Exchange traded some NASDAQ stocks, but was a distant third in market share.
- 14.
See Barclay et al. (1998).
- 15.
They use a Herfindahl–Hirschman Index as well as the number of nodes trading a stock to measure the degree of fragmentation before and after the switch to the NYSE and find that the gains in spread width and volatility are greater for firms experiencing more fragmentation prior to the decision to list on the NYSE.
- 16.
The findings of Murphy and Weaver also suggest that TSX members eventually began using order routing technology that allowed them to capitalize on the TSX crossing priority rule. This action dampened the impact of consolidation and spreads widened again.
- 17.
- 18.
Taken from Madhavan et al. (2005).
- 19.
Recall that NYSE specialists are involved in less than 20% of all trades.
- 20.
Assume that there are 100 shares offered at $19,200 at $19.05, 100 at $19.10, and 300 at $19.15. A market order to buy 500 shares will take out the sell orders from $19 to $19.15, leaving the best offer at $19.15 until new offers to sell arrive. This is sometimes referred to at walking the book.
- 21.
Assume a deeper market of 600 shares offered at $19. Then a 500 share order will not move the price.
- 22.
Recall that a similar situation existed on NASDAQ before the adoption of the OHR.
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Weaver, D.G. (2022). Networks, Nodes, and Priority Rules. In: Lee, CF., Lee, A.C. (eds) Encyclopedia of Finance. Springer, Cham. https://doi.org/10.1007/978-3-030-91231-4_45
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