Introducing financial trading rooms in business schools
M. Imtiaz Mazumder | Thursday, 12 June 2008
MOST of the public and private universities in Bangladesh offer both undergraduate and graduate degrees (BBA, MBA etc.) with major concentration in Business, Finance and Accounting. However, none is aware of whether these universities offer courses on stock trading and market micro-structure. The price discovery process of stocks is discussed theoretically and empirically in a 'market micro-structure and equity trading' course. Students may learn about investing in an 'investment and portfolio theory' course. But, stock trading is different from investing. However, both converge in the long run because portfolio managers trade to convert an investment decision to a portfolio position. Since many of these Finance and Accounting graduates will build their career as professional portfolio managers, buy/sell side analysts, investment bankers etc., it is important that they receive class-room training and experiment on real-life stock trading. An introduction of financial trading room in business schools of these universities will offer students a balance between theory and practice.
Fair stock price determination in the stock exchanges is a very complex process. Theoretically, the intrinsic value of a stock is nothing but the present value of its future cash flows (i.e. future earnings outlook, dividend prospects, financial condition etc.). However, the market value of a stock is the consensus price as determined by the interactions of numerous traders and market makers. As such, stock price formation is affected by (a) specific trading mechanisms (e.g. different forms of trade order flows and their execution procedures); (b) market arrangements (e.g. transparency and regulations, tax, explicit transaction costs such as brokers' fees and commissions, implicit transaction costs such as bid-ask spreads); and (c) other fundamental factors (e.g. wealth constraint and risk aversion, informed and uninformed trading, inventories, opportunity costs of delayed order executions and/or ignorance about the market fundamentals etc.). Nevertheless, expectations and beliefs about these factors are revised continuously with flows of new information and consequently stock prices fluctuate.
Increasingly and interestingly, the global capital markets are integrated in recent years. The macro objective of capital market is to allocate capital properly and enhance economic growth and development through cost-effective trading and efficient secondary market. The micro objective of capital market is to ensure price discovery. Both objectives are achieved in a liquid capital market by the interactions of market participants such as buyers/sellers, brokers, dealers, specialists/market makers, block traders, and banks, among others.
New technology, market structures and regulations attribute to the incredible and rapid integration of global stock markets. In the USA, over-the-counter markets such as Nasdaq and regional markets (e.g. Boston, Cincinnati, Pacific, Philadelphia, etc.) are now linked with the New York Stock Exchange (NYSE) and the American Stock Exchange (Amex) by computer through inter-market trading system (ITS). There are also Alternative Trading System (ATS) where liquid stocks are traded globally 24-hours a day through Electronic Communication Networks (ECNs) such as NYSE Arca (also known as Archipelago or ArcaEx), INET (previously known as Island ECN), Instinet, Xetra, Brut etc. However, each exchange has its own set of rules for trading which ultimately determines the security prices.
The price discovery process in a liquid market such as the NYSE is more transparent and promptly observable. A stock market is considered liquid if the ability to trade a large volume of stocks is much quicker with minimal transaction costs. The generic market structure of a well-developed liquid stock market is primarily order-driven; and secondarily quote-driven. For example, the NYSE has two distinct order-driven stock trading mechanism - call auction (used to determine a single market-clearing opening price) and continuous auction (used for the rest of the day to determine intra-day prices for each individual trade). Continuous auction trading mechanism ensures price stability and continuity of the market, and also establishes fair market price for stocks. For illiquid stocks which are traded infrequently, opening prices may not be determined using a call auction. Although order-driven markets are very common in general, but sometimes order-driven markets can break down due to major (good or bad) news outbreak. In such a situation, brokers may not handle the orders received from traders and market becomes quote-driven where dealers come forward with their inventories to make the market and keep it liquid.
It is a very common practice now that stocks are mainly traded through electronic/computerised trading platform. An electronic order-routing system such as Designated Order Turnaround (DOT - later it was improved and renamed as SuperDOT) allows the NYSE members/brokerage firms to transmit different trade orders (e.g. market order, limit order, stop order, stop-loss limit order, buy or sell stop orders etc., with sizeable volume either in odd or round lots) immediately to the specialists on trading floor via floor traders. In an electronic trading network, all quotes and order flows are displayed instantaneously, orders are filled immediately and trades are executed concurrently.
The introduction of computer technology in equity trading has increased trading volume. This also reduces operating costs, bid-ask spreads, and brokerage fees. Moreover, competitions among liquidity suppliers have increased dramatically with the introduction of automated trading. It should be mentioned here that informed traders, liquidity traders and technical traders are the major suppliers of order flows in a stock market. Admittedly, stock prices are influenced by their behaviour and actions. Market liquidity can be affected by many factors such as trading volume, frequency of trades, quoted and effective spread, breadth and depth of the market, and other market impact measures etc. Tick-size also determines the market liquidity and equity prices. For example, in July 1997, the tick size in the US stock exchanges was reduced from 1/8 to 1/16. Tick size was further reduced to one cent in March 2001 (which is known as penny tick or decimalisation). The introduction of penny tick adds market liquidity and reduces bid-ask spreads. To add further liquidity in the market, program trading (computer-directed stock trading executed automatically) is implemented. However, collars (i.e. suspension of program trading) and circuit breakers (i.e. restrictions on trading due to major market turmoil) are also used as safety-nets to avoid any market crash.
Now let us explore how students can be trained to execute theoretical foundations on asset pricing and stock trading in to practice. Recently, this scribe had the opportunity to attend a market micro-structure and financial trading seminar at the Wasserman Trading Floor in the Subotnick Financial Services Center of Baruch College's Zicklin School of Business in New York City. This financial trading room is virtual but replicates an actual security trading floor for both undergraduate and graduate students. It should be mentioned here that the NYSE (located at 11, Wall Street in lower Manhattan), Amex (86, Trinity Place in lower Manhattan) and Nasdaq MarketSite Tower as you see on CNBC or CNN Television (43rd Street and Broadway in Time Squares) are a few miles away from this trading floor of Baruch College. This provides an opportunity for converting this virtual trading room into an actual trading floor in case there is an emergency in these stock exchanges (as it happened after 9/11 when Wasserman Trading Floor was used by some displaced Wall Street brokers/traders).
Intra-day real-time tick-by-tick transactions' prices, quotes, and volume data are transmitted to several computer workstations at Baruch College's financial trading room directly from exchanges such as the NYSE, Nasdaq, Amex etc. Besides, historical data for individual stocks and indexes, options, exchange rate, media news and information are also delivered from other data vendors such as Reuters, DataStream, Compustat, Centre for Research in Security Prices (CRSP), Thomson Financial, Bloomberg etc. The trading floor is equipped with numerous dual-monitor computers, appropriate software and hardwires and networking infrastructure for trading simulation, spreadsheet analysis, modeling and calibration.
High definition Plasma/LCD display monitors exhibit real-time stock ticker, price and volume information in a financial trading room. Trading software, such as TraderEx, Metastock, eSignal, Real Tick etc., are commercially available for a trading room. For example, Baruch College's trading floor uses "TraderEx" (http:// www.etraderex.net/) which offers real-world order driven market and captures the dynamic properties of stock price formation. The Wharton School of University of Pennsylvania also offers a trading software, OTIS (Online Trading and Investment Simulator), that deals with portfolio construction, balance and diversification; industry sector analysis; application of various trade orders; short selling; margin trading etc.
A financial trading room provides students with a realistic market environment for stock trading. It allows students to integrate the finance theories with the real-life application and improve students' learning and education. Students can trade against computer generated order flows or be divided into groups (of 2-5 students depending on the class size) to trade against the order flows of each other and make instant trading decisions. They can place multiple trade orders simultaneously. They even can trade when they run out of cash (i.e. margin trading). Students can learn how stock price diverges (i.e. push the price away) when they trade too fast or miss the market when they trade too slowly.
Trading simulation also provides students with an opportunity to learn how prices and quotes are affected by both endogenous (such as order flows) and exogenous (such as information flows) factors. Based on the trading simulation, students can also be assigned to write a project where they may amalgamate their practical trading experiences with the theories learnt in classes. The performance of each group can be assessed in terms of profit/loss account and compared against a benchmark such as volume weighted average price of stock (VWAP). This is how portfolio managers are compensated according to their performance in a real-world scenario.
The Dhaka Stock Exchange (DSE) has become active since 1986 but the narrow breadth and depth, and poor regulations of the DSE make it less liquid. Thus, the price discovery process is probably less visible in the DSE. Still there are rooms for students to learn the stock price formation in the DSE. Under the current competitive business environment, business schools of different public and private universities in Bangladesh should come forward to establish financial trading rooms to offer practical education on stock trading. Companies listed in the DSE may come forward to sponsor such a financial trading room because they will eventually need quality graduates. Real time stock data can be arranged from the DSE or http://www.bdstock.com, a great website maintained by a non-resident Bangladeshi living in Utah, USA. Finally, relevant faculties should also be trained to offer quality and practical education on stock trading.
Many US companies, including big investment companies, stock brokerage firms, and financial companies currently are outsourcing jobs to countries where they find high quality graduates with practical experiences on stock trading analysis. The need for a financial trading room in business schools is a necessary condition to offer practical training on stock trading and to produce quality graduates.
Otherwise, like stock trading, if Bangladesh acts too slowly, it will miss this market and offshoring jobs will always remain as dreams but never be realised.
The author is Assistant Professor of Finance at the School of Business of State University of New York Institute of Technology in Utica, New York. He can be reached at Email:
m.imtiaz.mazumder@sunyit.edu
Fair stock price determination in the stock exchanges is a very complex process. Theoretically, the intrinsic value of a stock is nothing but the present value of its future cash flows (i.e. future earnings outlook, dividend prospects, financial condition etc.). However, the market value of a stock is the consensus price as determined by the interactions of numerous traders and market makers. As such, stock price formation is affected by (a) specific trading mechanisms (e.g. different forms of trade order flows and their execution procedures); (b) market arrangements (e.g. transparency and regulations, tax, explicit transaction costs such as brokers' fees and commissions, implicit transaction costs such as bid-ask spreads); and (c) other fundamental factors (e.g. wealth constraint and risk aversion, informed and uninformed trading, inventories, opportunity costs of delayed order executions and/or ignorance about the market fundamentals etc.). Nevertheless, expectations and beliefs about these factors are revised continuously with flows of new information and consequently stock prices fluctuate.
Increasingly and interestingly, the global capital markets are integrated in recent years. The macro objective of capital market is to allocate capital properly and enhance economic growth and development through cost-effective trading and efficient secondary market. The micro objective of capital market is to ensure price discovery. Both objectives are achieved in a liquid capital market by the interactions of market participants such as buyers/sellers, brokers, dealers, specialists/market makers, block traders, and banks, among others.
New technology, market structures and regulations attribute to the incredible and rapid integration of global stock markets. In the USA, over-the-counter markets such as Nasdaq and regional markets (e.g. Boston, Cincinnati, Pacific, Philadelphia, etc.) are now linked with the New York Stock Exchange (NYSE) and the American Stock Exchange (Amex) by computer through inter-market trading system (ITS). There are also Alternative Trading System (ATS) where liquid stocks are traded globally 24-hours a day through Electronic Communication Networks (ECNs) such as NYSE Arca (also known as Archipelago or ArcaEx), INET (previously known as Island ECN), Instinet, Xetra, Brut etc. However, each exchange has its own set of rules for trading which ultimately determines the security prices.
The price discovery process in a liquid market such as the NYSE is more transparent and promptly observable. A stock market is considered liquid if the ability to trade a large volume of stocks is much quicker with minimal transaction costs. The generic market structure of a well-developed liquid stock market is primarily order-driven; and secondarily quote-driven. For example, the NYSE has two distinct order-driven stock trading mechanism - call auction (used to determine a single market-clearing opening price) and continuous auction (used for the rest of the day to determine intra-day prices for each individual trade). Continuous auction trading mechanism ensures price stability and continuity of the market, and also establishes fair market price for stocks. For illiquid stocks which are traded infrequently, opening prices may not be determined using a call auction. Although order-driven markets are very common in general, but sometimes order-driven markets can break down due to major (good or bad) news outbreak. In such a situation, brokers may not handle the orders received from traders and market becomes quote-driven where dealers come forward with their inventories to make the market and keep it liquid.
It is a very common practice now that stocks are mainly traded through electronic/computerised trading platform. An electronic order-routing system such as Designated Order Turnaround (DOT - later it was improved and renamed as SuperDOT) allows the NYSE members/brokerage firms to transmit different trade orders (e.g. market order, limit order, stop order, stop-loss limit order, buy or sell stop orders etc., with sizeable volume either in odd or round lots) immediately to the specialists on trading floor via floor traders. In an electronic trading network, all quotes and order flows are displayed instantaneously, orders are filled immediately and trades are executed concurrently.
The introduction of computer technology in equity trading has increased trading volume. This also reduces operating costs, bid-ask spreads, and brokerage fees. Moreover, competitions among liquidity suppliers have increased dramatically with the introduction of automated trading. It should be mentioned here that informed traders, liquidity traders and technical traders are the major suppliers of order flows in a stock market. Admittedly, stock prices are influenced by their behaviour and actions. Market liquidity can be affected by many factors such as trading volume, frequency of trades, quoted and effective spread, breadth and depth of the market, and other market impact measures etc. Tick-size also determines the market liquidity and equity prices. For example, in July 1997, the tick size in the US stock exchanges was reduced from 1/8 to 1/16. Tick size was further reduced to one cent in March 2001 (which is known as penny tick or decimalisation). The introduction of penny tick adds market liquidity and reduces bid-ask spreads. To add further liquidity in the market, program trading (computer-directed stock trading executed automatically) is implemented. However, collars (i.e. suspension of program trading) and circuit breakers (i.e. restrictions on trading due to major market turmoil) are also used as safety-nets to avoid any market crash.
Now let us explore how students can be trained to execute theoretical foundations on asset pricing and stock trading in to practice. Recently, this scribe had the opportunity to attend a market micro-structure and financial trading seminar at the Wasserman Trading Floor in the Subotnick Financial Services Center of Baruch College's Zicklin School of Business in New York City. This financial trading room is virtual but replicates an actual security trading floor for both undergraduate and graduate students. It should be mentioned here that the NYSE (located at 11, Wall Street in lower Manhattan), Amex (86, Trinity Place in lower Manhattan) and Nasdaq MarketSite Tower as you see on CNBC or CNN Television (43rd Street and Broadway in Time Squares) are a few miles away from this trading floor of Baruch College. This provides an opportunity for converting this virtual trading room into an actual trading floor in case there is an emergency in these stock exchanges (as it happened after 9/11 when Wasserman Trading Floor was used by some displaced Wall Street brokers/traders).
Intra-day real-time tick-by-tick transactions' prices, quotes, and volume data are transmitted to several computer workstations at Baruch College's financial trading room directly from exchanges such as the NYSE, Nasdaq, Amex etc. Besides, historical data for individual stocks and indexes, options, exchange rate, media news and information are also delivered from other data vendors such as Reuters, DataStream, Compustat, Centre for Research in Security Prices (CRSP), Thomson Financial, Bloomberg etc. The trading floor is equipped with numerous dual-monitor computers, appropriate software and hardwires and networking infrastructure for trading simulation, spreadsheet analysis, modeling and calibration.
High definition Plasma/LCD display monitors exhibit real-time stock ticker, price and volume information in a financial trading room. Trading software, such as TraderEx, Metastock, eSignal, Real Tick etc., are commercially available for a trading room. For example, Baruch College's trading floor uses "TraderEx" (http:// www.etraderex.net/) which offers real-world order driven market and captures the dynamic properties of stock price formation. The Wharton School of University of Pennsylvania also offers a trading software, OTIS (Online Trading and Investment Simulator), that deals with portfolio construction, balance and diversification; industry sector analysis; application of various trade orders; short selling; margin trading etc.
A financial trading room provides students with a realistic market environment for stock trading. It allows students to integrate the finance theories with the real-life application and improve students' learning and education. Students can trade against computer generated order flows or be divided into groups (of 2-5 students depending on the class size) to trade against the order flows of each other and make instant trading decisions. They can place multiple trade orders simultaneously. They even can trade when they run out of cash (i.e. margin trading). Students can learn how stock price diverges (i.e. push the price away) when they trade too fast or miss the market when they trade too slowly.
Trading simulation also provides students with an opportunity to learn how prices and quotes are affected by both endogenous (such as order flows) and exogenous (such as information flows) factors. Based on the trading simulation, students can also be assigned to write a project where they may amalgamate their practical trading experiences with the theories learnt in classes. The performance of each group can be assessed in terms of profit/loss account and compared against a benchmark such as volume weighted average price of stock (VWAP). This is how portfolio managers are compensated according to their performance in a real-world scenario.
The Dhaka Stock Exchange (DSE) has become active since 1986 but the narrow breadth and depth, and poor regulations of the DSE make it less liquid. Thus, the price discovery process is probably less visible in the DSE. Still there are rooms for students to learn the stock price formation in the DSE. Under the current competitive business environment, business schools of different public and private universities in Bangladesh should come forward to establish financial trading rooms to offer practical education on stock trading. Companies listed in the DSE may come forward to sponsor such a financial trading room because they will eventually need quality graduates. Real time stock data can be arranged from the DSE or http://www.bdstock.com, a great website maintained by a non-resident Bangladeshi living in Utah, USA. Finally, relevant faculties should also be trained to offer quality and practical education on stock trading.
Many US companies, including big investment companies, stock brokerage firms, and financial companies currently are outsourcing jobs to countries where they find high quality graduates with practical experiences on stock trading analysis. The need for a financial trading room in business schools is a necessary condition to offer practical training on stock trading and to produce quality graduates.
Otherwise, like stock trading, if Bangladesh acts too slowly, it will miss this market and offshoring jobs will always remain as dreams but never be realised.
The author is Assistant Professor of Finance at the School of Business of State University of New York Institute of Technology in Utica, New York. He can be reached at Email:
m.imtiaz.mazumder@sunyit.edu