How SOES Trading Influenced Today’s Wall Street Landscape

Small Order Execution System, was created in 1988 by Nasdaq for Nasdaq stocks allowing brokers to execute orders up to 1000 shares. The system enabled brokers to bypass using the phone to call a market maker and was now computerized and automated. SOES was created in response to the 1987 stock market’s crash lack of liquidity and partially in response to the market makers backing away (not executing) from their stated quotes. SOES daytrading became a thorn in the side to the market makers in the early 1990’s who did everything they could to try to abolish it yet it is still around today in a different form and most of the SOES components have influenced what all investors are using today.

SOES daytraders sat in front of Nasdaq level 2 computer screens which showed a real time scroll ticker of Nasdaq stocks and changes in the quotes by the market makers to a particular stock that a trader might be interested in trading. This leveled the playing field against the good ol’ boys. They could then execute a trade via computer to computer. This was the first time the general public had access to real time quotes and almost instantaneous execution although only used by the so called SOES bandits. During that time no one else had access to level 2 quotes. Most of the general public received delayed quotes and executed their trades by calling their broker. Today, against the wishes of the market makers, everybody can have access to real time and level 2 quotes. Almost all general public stock transactions are now computerized bypassing the time it takes to call and speak to a broker.

One of the best things for today’s investor came indirectly from SOES daytrading, the reduction of the market makers spread between the bid and ask. Today it is quoted in pennies. In the old days the market makers would quote prices in fractions with the minimum spread being a 1/8, liquid stocks were quoted in 1/4 point spreads, and illiquid stocks were quoted in 1/2 point spreads and up. The Wall Street bookies could trade their order flow and make a nice built in profit on their spread. That all came to end when the SEC, who on behalf of the market makers, were trying to shut down Harvey Houtkin’s SOES daytrading firm. Houtkin, considered the father of SOES daytrading, began to show the world how corrupt the market makers were. He became a market maker. What did he do? He went to the most liquid stocks which were trading in 1/4 spreads and set his market at 1/8 spread. The spread for example on Intel (INTC) went from 50 x 50 1/4 to 50 x 50 1/8. The funny thing was, nobody else joined him to quote a 1/8 offer. Why? The good ol’ boys money printing presses were found guilty of collusion to keep the spreads artificially wide. The market makers settled for over a billion dollars in one of the biggest class action suites ever. This is why today’s investor sees a spread quoted in pennies.

The SOES daytraders used the selectnet system to get out of their orders in between the artificially high quoted spreads. For example, if a trader was long Intel which was quoted on the level 2 screen at 50 x 50 1/4, the SOES trader could offer it out at 50 1/8 and hope to get hit. Selectnet was the forefather to the ECN’s (electronic communication network). Island ECN was created for SOES traders and others followed. Today, ECNs make up almost all the quotes on the level 2 screen.

Today, when an investor or trader sits down at his computer to buy a stock, he or she can have access to real time quotes, direct order entry, and level 2 quotes showing prices of bids and asks that are mostly quoted by ECNs. He or she puts in his price to buy or sell in decimals, pushes the submit button and if it’s an executable order (ex. market order) you will receive an order filled confirmation in seconds. All of these things are derivatives from SOES daytrading

By: Steve Megna