What Are The Different Types of Alternative Trading Systems?

Herd mentality often runs wild in public equities markets, especially when large trade orders are executed. 

Large purchase transactions are often followed by a host of additional buyer-initiated transactions, while large sell orders are often followed by a mass selloff. High-volume trading velocity can swing a stock’s pricing up or down like a teeter-totter. Institutional investors and professional traders who want to initiate large-volume trades often turn to alternative trading systems (ATS) because these platforms aren’t available to the public and won’t lead to bull or bear runs on a particular stock. 

Let’s take a closer look at how alternative trading systems function and highlight the main types of ATS. 

How Alternative Trading Systems Work 

Alternative trading systems are electronic platforms that function much like public stock exchanges – only securities that have already been listed on public equities markets are available for trade on an ATS. However, trades can be executed after hours and from any geographical location in the world.  

Unlike traditional exchanges, which are highly regulated, ATS are more loosely regulated; however, they still are required to operate under a regulatory framework established by the Securities & Exchange Commission. The majority of alternative trading systems are registered as broker-dealers with the SEC. The main purpose of alternative trading systems is to pair subscribers with transactions, especially for large trades that can number in the hundreds of thousands or millions of shares. 

All alternative trading systems are known as “dark pools” because trades that take place on these systems aren’t public record. This opacity prevents retail investors from seeing execution pricing or trade volume, which reduces price distortion in public exchanges. It also minimizes the ripple effects of herd mentality on the price of an equity. 

A perfect example: Remember the legendary trading floor scene in the 1983 comedy “Trading Places?” The Duke brothers (the late Ralph Bellamy and Don Ameche) used falsified insider information to buy massive amounts of frozen orange juice contracts. Their huge buy orders sparked a buying frenzy that sent the price of frozen OJ skyrocketing. The characters played by Eddie Murphy and Dan Akroyd, meanwhile, initiated an even greater buying frenzy by offering to sell frozen OJ contracts at $1.42 a pound. After the Secretary of Agriculture announced that the OJ crop survived the winter’s hard freeze, and OJ prices would remain low, buyers instantly became panicked sellers, eventually unloading their shares at a mere $.29 a pound. The antagonists were ruined, and the protagonists were instant multi-millionaires. 

By using an ATS, though, traders can buy or sell massive amounts of shares of an equity and avoid skewing share prices on public markets. 

Here are the main types of alternative trading systems. 

Electronic Communications Systems 

Electronic communications systems (ECNs) are the most widely used ATS. These fully computerized forums or networks enable brokerage houses and professional traders to make trades without using an intermediary to process their transactions. Trades may happen after normal trading hours, and from any location in the world. 

ECNs typically charge traders access and transaction fees, along with commissions. 

Crossing Networks 

Crossing networks are electronic platforms that match buy and sell orders at predetermined points throughout the trading day, as well as after the closing bell rings. 

Crossing networks typically have a set membership that buys and sells securities among themselves. Securities also may be restricted to just a particular subset of the network’s membership. Crossing networks also may be used by company executives to divest large volumes of stock without negatively impacting the value of the company’s stock.  

Call Markets 

Call markets, also called call auctions, are electronic trading platforms that only allow trade orders to be executed at predetermined times. An auctioneer aggregates buy and sell orders, which are executed at certain times of the day. Sellers determine their minimum price, while buyers set their maximum. The auctioneer is tasked with matching supply with demand to determine a clearing price, and trade orders are executed at that price. 

Putting it All Together 

Institutional investors who want to keep extremely large purchase or sell orders out of the public eye often use alternative trading systems to execute high-volume trades. These trades aren’t public knowledge, so they don’t adversely affect a company’s stock price. Typically, ATS are used to pair transactions with institutional buyers and sellers. They provide a diverse alternative trading ecosystem that meets the needs of institutional investors.