Trading and Exchanges Chapter 3: The Trading Industry - Regulation and Market Types (Part 2)
In Part 1 we covered the players: buy side, sell side, brokers, dealers. Now Harris walks us through what they actually trade, where they trade it, and who makes sure nobody burns the whole thing down.
Stock Markets: More Competition Than You Think
When a company goes public, it applies to get its stock listed on an exchange. The exchange checks minimum capital value, enough shareholders, proper financial reporting.
But here is the thing most people miss. A stock doesn’t just trade on one exchange. In the US, NYSE-listed stocks also trade on regional exchanges, the Nasdaq Intermarket (“third market”), and various electronic trading systems (“fourth market”). Your shares could change hands in five or six different places.
All these venues compete for your order. Competition usually means better prices. But volume numbers get weird. When a dealer sits between a buyer and seller on Nasdaq, that one trade gets counted as two (or three if multiple dealers are involved). So when someone says Nasdaq volume is bigger than NYSE, keep that in mind.
Beyond Stocks: Where the Real Money Moves
Harris makes it clear that stocks get way more attention than they deserve based on actual trading volume. Here are the other markets that are honestly more important:
Options markets. Five exchanges traded standardized options in the US at the time Harris wrote the book. The cool part: all contracts clear through the Options Clearing Corporation, so you can buy on one exchange and sell on another. The International Securities Exchange, which launched in 2000 as fully electronic, was already eating the lunch of the old floor-based exchanges. Electronic wins. Every time.
Futures markets. Unlike options, each futures exchange runs its own clearinghouse. So exchanges don’t compete on the same contract. Instead, they compete by designing contracts that attract traders. Front month contracts get the most action in financial futures. For agricultural stuff, the first harvest contract is where hedgers and speculators care most. Makes sense: that’s where the real uncertainty is.
Bonds. Here is a fact that might surprise you. Less than 0.1 percent of corporate bond trading happens on exchanges. Almost everything is over the counter at investment banks. Those bond price tables in the newspaper? Basically unreliable.
Treasury markets. Governments sell their debt through auctions. In the US, the Federal Reserve is the biggest player. The Fed traders at the New York Fed bought $44 billion in unmatched transactions and another $4.4 trillion in repos in 2000. And they don’t get year-end bonuses. Life is unfair.
Currency markets. Hugely liquid because every cross-border transaction needs a currency conversion. Mostly OTC. And if you ever exchanged money at an airport kiosk, you already participated in the retail currency market. You also got ripped off. ATM withdrawals abroad give you much better rates because your bank has negotiating power you don’t.
Regulation: The Necessary Evil
Harris is refreshingly honest about regulation. Most traders believe markets work best when well regulated but not excessively regulated. Good regulation helps people communicate, prevents fraud, and makes sure things are what they appear to be.
Bad regulation? That exists too. Harris points out that the stated purpose of a regulation is often not its true objective. Regulators can protect domestic markets from foreign competition. They can protect incumbents from new competitors. They can impose taxes that backfire spectacularly.
His Brazil example is perfect. In 1997, Brazil put a 0.38% tax on all financial transactions. Result? Institutional traders just moved to trading Brazilian stocks as ADRs in New York. Daily volume at the Sao Paulo Bovespa crashed from 1.2 billion reais to 350 million reais. The government had to reverse course. Congratulations, you played yourself.
Who Regulates What
In the US, regulation is split between the SEC (stocks, bonds, options) and the CFTC (commodity futures). Most countries use one agency. Having two creates turf wars. The Shad-Johnson Accord of 1982 divided responsibilities, but the result is two agencies separately regulating instruments with nearly identical risk. Some call this healthy competition. Others call it bureaucratic waste.
Then you have self-regulatory organizations (SROs) like the NASD and NFA. Exchanges regulate trading practices. Clearinghouses set capital standards. SROs enforce rules by threatening to expel members. Works when compliance costs are low. Fails when dishonest members can profit big from breaking rules.
Fun fact: onion futures are still illegal in the US. In the 1950s, farmers blamed speculators for price volatility, lobbied Congress, and got onion futures banned. Now the people who could actually benefit from hedging onion prices can’t use futures. Classic unintended consequence.
The Big Picture
This chapter is really about understanding that the trading industry is a whole ecosystem. It’s not just the stock market. It’s stocks, bonds, futures, options, currencies, swaps, real estate, all connected through overlapping networks of exchanges, dealers, brokers, clearinghouses, and regulators.
And every part of this ecosystem is constantly competing, consolidating, and evolving. Electronic markets are replacing floors. Exchanges are merging. Regulators are fighting over jurisdiction. New instruments keep appearing.
The lesson? If you trade anything, understanding this plumbing matters. Not because it’s exciting reading, but because the structure of the market you’re in determines how much you pay, how fast you get filled, and who is taking the other side of your trade.
Previous: Chapter 3: The Trading Industry (Part 1)