The Difference Between NYSE and Nasdaq: Who Is Master, Man or Machine?

By: Ray Pellecchia

File Under: NYSE, NYSE Arca

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Here's a story that has not been reported to date: Last Friday's unprecedented trading activity revealed more about the difference among markets than any day since, perhaps, 19 Oct. 1987.

Let me explain.

Recall the events of last Friday. It was crunch time for U.S. markets, right from the get-go. It was the quarterly expiration of stock-index options and futures. Stock prices exploded upward at the opening, driven by the announcement that Washington was working on a huge financial bailout. And the SEC had just announced a new ban on short selling in approximately 800 issues, which initially resulted in confusion among traders, many of whom pulled their bids and offers until they could sort out whether they could short, whether they were exempt, which stocks were shortable and which weren't.

All of that helped produce record trading volume on the NYSE in the first half hour, the first hour, and for the full day. In our opening auction alone, NYSE executed 744 million shares, or 98.8 percent of the consolidated opening volume.

The electronic markets, too, were doing a lot of business, but there was a difference. Nasdaq had to cancel more than 1,000 trades in NYSE-listed issues in the first 10 minutes of trading. For the full day, Nasdaq would go on to cancel 11,000 trades in stocks listed on itself, NYSE and the Amex.

The number of NYSE cancels for the day: none. Zero, zip, zilch. Nada.

Here's why. On the NYSE, there are people with machines (algorithmic trading tools), not just machines. So when there are all buyers and virtually no sellers, or vice versa, there are people who risk capital on the contra side, people who bring in customers on the contra side, and a process that injects some time and transparency so that the market can find equilibrium and discover a real price.

In contrast, on solely electronic markets, when there are all buyers and virtually no sellers, there are only computers, doing what they are designed to do: matching bids and offers quickly. When the market is all on one side, you're going to get a market-clearing price, and it's very likely you're going to be extremely happy or extremely unhappy.

Last Friday, there were thousands of such trades taking place in electronic markets, and those markets got together to agree to cancel opening trades that took place 20 percent or more away from the previous day's close. It wasn't just Nasdaq but all electronic markets, including our own NYSE Arca, as well as Bats.

That said, if you're an issuer, where do you want to be listed: with the exchange group that gives investors the choice between trading on markets that are fully automated (NYSE Arca) or high-tech/high-touch (NYSE); or the exchange group that gives your investors no choice? It sure came in handy last Friday to have the two models. And Friday was only a dramatic example of what happens all the time, albeit on a smaller scale.

The cancels were only part of it. Look at the trades that weren't cancelled. Some 327 of Nasdaq's 1,090 opens were outside the full-day NYSE trading range. Of these, 26 were in the top 100 NYSE-listed stocks by share volume. Nasdaq’s average open was more than 14% away from the NYSE crossing price.

For example:

• Nasdaq opened AMR at $12.45, less than 30 seconds before the NYSE open. The consolidated high between the Nasdaq opening cross and the NYSE open was $12.39. NYSE opened AMR at $12.15, and in the next 3 minutes, it traded only as high as $12.28.

• GE opened at $29.12 on Nasdaq, less than 24 seconds before NYSE opened it at $28.80. Nasdaq traded more than 205K shares in its opening cross. NYSE auctioned 16.1 million shares. In the three minutes after NYSE opened GE, the high was $28.85.

• Deutsche Bank opened at $87.00 on the NYSE for 42,100 shares versus $90.00 on Nasdaq for 525 shares. The full-day NYSE high was $88.13.

• Morgan Stanley opened on 4.1 million shares on the NYSE at $32.04. Nasdaq crossed 39,929 at $33.06. The full-day NYSE high was $32.20.

• Build-A-Bear Workshop opened on 133,300 shares at NYSE. On Nasdaq, BBW crossed 100 shares at $7.26. The NYSE low for the day was $7.90.

• Nasdaq crossed 1,000 shares of AGM at $14.78. The NYSE’s open of 90,400 shares was at $17.55, and the low of the day on NYSE was $16.67.

So if you want it fast, or you want it right (and still pretty fast), NYSE Euronext offers you the choice of both. The other guys, not so much.

Looking across the market, you can also compare how the stocks traded in aggregate, immediately after the opening. We examined the NYSE opening auction price and volume-weighted average price (VWAP) during the ensuing 10 minutes versus Nasdaq's open in NYSE issues and the VWAP for the 10 minutes after it crossed NYSE stocks. In the two minutes after the NYSE opens, the median VWAP differential to the NYSE open price was 15 basis points (bps), vs. 180 bps on Nasdaq.

In other words, the price variation following NYSE's opening was 1/12th that of Nasdaq's opening in NYSE stocks.

A hat tip to my colleague Steve Poser for the analysis in this post.

I don't intend this to diss electronic markets. Again, they did exactly what they were designed to do, and that's exactly what some people want markets to do. But I do intend to underscore something that is often misunderstood and misstated: The real struggle in markets is not man versus machine; it is machine versus man-with-machine. Last Friday demonstrated the value of the latter, here at NYSE.

There is a clear difference between NYSE Euronext and Nasdaq OMX, as illustrated last Friday, and that difference is choice for issuers and their investors and traders, and that difference is people. Even in this day of automation, choice and people really can and do make a positive difference.

Sorry for the long-winded post. Have a good weekend.