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Thursday, April 07, 2005

SEC Approves Trade-Through Rule

The SEC just approved changes prohibiting trade-throughs, which occur when an order to buy or sell stock bypasses the market displaying the best price to another market with a worse price.

IMHO, the regulation is a bad one because of the accelerated pace at which transactions occur in today's market. In my understanding (full disclosure: I'm a corporate finance guy, not a microstructure expert), large investors focus on "effective price" rather than quoted price. So, an investor with an order for, say, 10,000 shares might prefer to execute the whole order at $50.01 rather than be forced to execture a portion at $50 first. In the second case, if the stock trades frequently (Microsoft often has a dozen or more stroc transactions in a second), by the time a portion of the order is executed at the $50 price, the second quote may be filled, and the price could have moven upward.

For a good and non-technical explanation of this argument, read this recent letter to the Wall Street Journal by Charles Schwab, titled "May We Trade Through". He says is as well as I've heard yet.

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