A recent Bloomberg article titled “Goldman Tops JPMorgan as Best Broker as Speed Shakes Up Trading” published on 1/29/10 ranks the world’s top global brokers based on transaction costs incurred by their institutional investor customers. Transaction cost as defined in this article is the difference between the executed stock price and the price when the order was placed. $7.5 trillion dollars worth of transactions over a one year period were reviewed. Below are the transaction costs per broker: 

 

 

 

The average transaction cost before commissions is .35% of the gross dollars traded. This amounts to $26 billion dollars of annual transactional cost. According to an article in Forbes Magazine titled, “The New Masters of Wall Street” published on 9/2/09 high frequency traders made a $21 billion dollar profit during the same time period. We believe this is due in part to a major flaw in the market structure which occurs when brokers work orders on behalf of their institutional investors. 

Institutional investors generally trade very large orders. The most efficient trading method brokers or institutional investors themselves try to use to hold down transaction costs is to take a large order and break it up into smaller orders and enter the smaller orders into the market over a specific time period.   When these smaller orders enter the market they tend to move the market in a single direction. 

When a high frequency trader identifies an institutional sell order coming into the market, he will sell or sell short the security while the large institutional sell order drips small sell orders into

the market. This practice increases the downward pressure on the security price which directly increases institutional investor's transaction costs. This also works vice versa when brokers work institutional investors' buy orders.

During the "time period" the broker works the order, the institutional investor's order is exposed to the high frequency trader. We feel that high frequency traders as a group are able to forcibly extracted at least .15% out of the average institutional investor order due to this exposure during the time period analyzed. As a result institutional investors lost $11 billion dollars.

Deep Liquidity is introducing a new market structure that eliminates the need for institutional investors to expose their large orders to the market. Deep Liquidity's market structure introduces "new incentives" to liquidity providers which allow them to quote almost any size of order in real time.

Deep Liquidity's process is simple, institutional investors anonymously advertise to the market the "symbol" or "symbol and shares" of the securities they want to trade without disclosing if they are buying or selling. Liquidity providers respond to the advertisements by sending a new type of peer to peer "smart" quote back to the desktop of the institutional investor. These new type of "smart" quotes can be priced in direct proportion to the risk associated with filling them. This allows institutional investors the ability to construct private non-binding auctions for each order. This capital market construction occurs on the desktop of the institutional investor resulting in price discovery for almost any size of order without committing to trade.

If competition between liquidity providers can be utilized in a new price/size discovery process for large orders combined with preventing the high frequency trader from arbitraging price distortions caused by institutional order flow costs to the institutional investor could drop by 75%. We believe if Deep Liquidity market structure was utilized for the time period analyzed, institutional investors would have saved $19 billion dollars.

*We define high frequency trading as any computerized trading strategy that's profit is in direct proportion to the level of institutional order flow coming into the market. This is a broader definition of high frequency trading than some security industry definitions. Deep Liquidity holds patents in the U.S. and Japan for its "smart quote."