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Liquidity and quote fading

Published in Automated Trader Magazine Issue 39 Q2 2016

Commentators on electronic markets claim that liquidity can 'disappear in an instant'. Quotes, they say, tend to fade as soon as the market notices that there is a seller around. By Remco Lenterman

I'm always rather bemused by this observation, because it implies that in more manual markets, liquidity is (or was) more stable. That's certainly not my personal observation, having traded many manual markets and many electronic markets over the course of my career. Let's take a trip down memory lane…

In the mid 90s I had the good fortune of being a Nasdaq market maker in New York with a large firm. Some of you may believe that Nasdaq was an electronic exchange back then, but I can assure you it wasn't. Nasdaq worked like this:

Market makers would enter their quotes manually onto a screen, usually in 1,000s of shares with 1-2 USD spreads. These quotes were not auto-executable like they are today (except for SOES orders, but that's a different story) but broker-dealers had to honour the quote that was on the screen as soon as they picked up the phone.

If, for example, I had an order to sell shares in Ericsson, I had to call the broker-dealers that were on the best bid at that time. So if the stock had 16 broker-dealers on the bid, each bidding 21.25 USD for 1,000 shares, I'd call one and say, "10,000 Ericsson at a quarter, selling them" 1 . That broker would say "buy a 1,000" because that was the size he was bidding for and he'd move his quote down by 1/8 2 .

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