What's Lurking in the (Wed) Bushes? Investor Relations and High Frequency Trading

Why does Wedbush Morgan dominate order flow?

Have you looked at your list of market participants lately? If you're a large, liquid issue,regardless of whether you are listed on NYSE or Nasdaq, Wedbush probably ranks high. In September 2007, Wedbush topped all liquidity providers at the Nasdaq, surpassing Morgan Stanley, Citadel Derivatives, Instinet and Lime Brokerage.

Los Angeles based Wedbush, once just another mid-tier bank toiling in the long shadows of the bulge brackets like Morgan has carved itself a niche. Our Top 25 Volume report for Oct 29-Nov 2 showed Wedbush with 9% of total order flow. Is Wedbush's Maximus fast-trading platform dominating other trading systems, or is there more to what's going on here? And why should you care, IROs?

First, we need to differentiate between liquidity providers and liquidity users. In a 2005 Traders Magazine interview, Dave Cummings, founder of both Tradebot and BIDS Trading, stated: "Liquidity providers have always existed to facilitate the immediate demands for liquidity by long term investors. That process has gotten much more efficient the last few years with the black boxes, such as Tradebot and others, fighting each other to try to average a tenth of a penny profit per share. Liquidity takers will continue to get a good deal if the competitive playing field is preserved."

Put simply, in order for investors to efficiently buy and sell securities, someone has to, in effect, fill the till with cash at the counter. Otherwise, the process of buying and selling securities would be far more volatile (as if they aren't anyway!). What has happened since trading supergeek Cummings made those comments is that the movement of shares has become positively frenetic, requiring much more change in the cash register to keep pace.

Order flow quantified by ModernIr as "high-frequency trading," or the provision of liquidity, now accounts for over 20% of the total we parse each week - because the definition of "long-term investor" has changed, quant investors are far more active, fundamental investors continually employ algorithms to manage risk, and ETFs require constant adjustments to underlying mixes of securities.

Result: The Wedbushes filling tills with change for the trading day drive enormous volumes. They turn profits by furnishing shares to exchanges and market centers, not through conventional brokerage.

IROs, it's yet another reason why accurate answers require different tools and information. Example: say your surveillance firm tells you they think Renaissance was selling. So? Renaissance is constantly selling or buying, often thousands of times per second. What's more important is whether they were doing it as part of broader rotation - something that can be seen if you watch whether liquidity provision is growing in sequence or not. Plus, you can use the ebb and flow of liquidity provision to your advantage when targeting investors. All reasons to know your market structure.

Tim Quast is a fifteen-year Investor Relations veteran and founder and managing director of ModernIR.com, which parses and categorizes over a half-billion shares per week with its trading intelligence systems. Want more information? Check out our Frequently Asked Questions or visit modernir.com.