What are Alternative Trading Systems?

Alternative trading systems are systems used for trading securities. They are approved by the Securities and Exchange Commission, but operate outside of the traditional stock exchanges. According to the Securities and Exchange Commission’s Regulation ATS, an alternative trading system is “any organization, association, person, group of persons or system that constitutes, maintains, or provides a market place or facilities for bringing together purchasers and sellers of securities or for otherwise performing with respect to securities the functions commonly performed by a stock exchange.”

An electronic communication network (ECN) is an alternative trading system for stocks and currencies. An ECN is used for active trading, with the trading system matching buy and sell orders. Orders that cannot be matched are displayed so that matching orders can be submitted by interested parties. Individuals or brokers can subscribe to an electronic communication network. Instinet is first and biggest electronic communication network.

Alternative trading systems are useful for inter-market trading, as stocks listed on another exchange, such as the New York Stock Exchange (NYSE) or Nasdaq, can be traded on electronic communication networks. The costs associated with trading on an alternative trading system tend to be lower, as trades are executed electronically. More people can access the market through alternative trading systems than through a centralized market such as the NYSE. This means that prices of securities traded on alternative trading systems will, theoretically, be more representative of their true value, because the free market forces of supply and demand are acting unfettered.

If an institutional investor wants to buy or sell a large quantity of a particular security, using crossing network, a type of alternative trading system, can be preferable to performing the transaction on a traditional exchange. The purchase or sale of a large block of stock on a traditional exchange can often move the price of that security. Trading on a crossing network, which matches orders without routing them through an exchange or electronic communication network, will not do that, because the buy and sell orders are matched and executed anonymously. These alternative trading systems do not have the characteristic of bidding the price up or down, as centralized markets do.

Another type of alternative trading system is the call market. In a call market, many orders are grouped together. Once the orders reach a certain volume, the group of orders is executed at the same time. This increases efficiency and reduces costs.