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Trading Technology

12:40 PM
Andrew Rafalaf
Andrew Rafalaf
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The Second Coming of Merrin

Will LiquidNet Succeed Where Others Have Failed?

Because of this hands-off style, LiquidNet fits right into the trader's day and the way they already trade. Many industry observers point out that the satisfaction curves found in Optimark spoke to the way portfolio managers want trades to be done, but not to the needs of traders, another reason the system didn't catch on. Traders are typically far more focused on what the crowd is doing than on execution. Harold Bradley, CEO of American Century Ventures, a major Optimark investor, admits, ""I loved Optimark as a portfolio manager, not as a trader, because it was how I worked my portfolio. If I had a stock that was in trouble and I wanted to get rid of it, the worst thing to do was to go and work that on the floor.""

Kevin Cronin, head of listed equities at AIM Funds, and a former Optimark user, echoes the sentiments felt by many. However sophisticated the technology, Optimark was never designed with the trader in mind. ""I think Optimark is certainly a good example of a system that was built on an incredible technology platform, but it did not consult what our significant needs were vis a vis supply and demand,"" notes Cronin, also a member of the LiquidNet Advisory Board. ""You can have the best technology in the world, but if it doesn't apply the way people need it to be applied, then its nothing more than an impressive array of technology.""As an attempt to answer to the needs of buy-side traders—its very market—Merrin has assembled a LiquidNet Advisory Board that includes heads of trading from such firms as AIM Funds, Scudder Kemper, T. Rowe Price and Putnam Investments. Just to be sure, the LiquidNet board of directors includes such industry titans as Nathan Gantcher, ex-CEO of CIBC Oppenheimer, Michael Price, chairman Franklin Mutual Series, Lou Ricciardelli, CEO BPB Associates and Larry Zicklin, chairman of Neu-berger Berman.

""One of the problems that some other systems have had recently is that they didn't seek out the insight of enough buy-side traders to make them successful,"" says Cronin. ""I think Seth has been proactive in that he has sought and gotten a lot of input ... to make sure the system has thought about all the possible angles it needs to think about."" Optimark's Colgan admits how difficult his system can be to use, and the company has released new functionality to counter that complaint. Users may save ""trading strategies"" that can be used again and again. ""We created a strategy engine that allows a trader to enter in once, and execute a number of times,"" he demonstrates. ""He can have strategy A, B or C.""

Liquidity is Borne on Liquidity

Because of the aforementioned flaws, Optimark just never accumulated the kind of volume it required to be effective. Optimark is, in many ways, a very complex crossing network like Posit. Unlike Posit, which crosses trades once an hour, Optimark seeks to do so every three to five minutes. To match trades at such a pace, Optimark would need to accumulate an immeasurable amount of volume. Merrin points out that Optimark never solved the ""chicken and the egg"" problem. Traders will only commit trades where they find liquidity, but liquidity only comes when traders commit trades. Given the fact that the system crosses every five minutes, there would have to be a large number of trades entered within each crossing window to have any matching success. Those traders that did enter in trades early on found no liquidity on the system and just stopped using it. Whereas volume begets volume, a lack of volume begets less volume in a destructive, downward spiral.

""Using this proactive model, they're asking traders to enter orders in the hope of having other traders enter in exactly the contraside,"" Merrin points out. ""Combine that with the point-in-time problem, that they only had three to five minutes, Optimark had maybe one week to develop a critical mass of liquidity. If traders aren't getting orders done, they just stop coming to the party.""

Merrin assures that LiquidNet will provide liquidity right out of the box because of its integration with the firms' order management systems. ""If they're working 100 orders for the day, the system knows they have 100 orders, and if they've got a million shares to buy the system knows a million shares,"" he adds. ""We're dealing with the largest buy-side institutions so we start with a critical mass from day one.""

Instinet took 15 years to build up the needed liquidity and Posit has taken over eight.

And unlike the centralized models of Posit, Instinet and Optimark, LiquidNet is a distributed environment. Like Napster, the online MP3 file sharing system, LiquidNet turns every trader's PC into a possible file or trading server. And there is no one place on LiquidNet where traders can view what their competitors might be doing. Posit and Instinet claim complete anonymity, but traders are well aware that that isn't the case, particularly because of the human intervention found on both systems. Because both Posit and Instinet employ traders, those traders have access to all the trades placed on the networks, and are known to divulge that information to other users. As a result, traders hold back order flow they would otherwise transmit.

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