Craig W. Holden, Richard G. Brinkman Faculty Fellow and Associate Professor


BU 356C

Office Hours:

Tues-Thurs, 12:30-2:00 or feel free to drop by any time!

Office Phone:


Web site:

Course web site:




Welcome to Security Trading and Market Making at Indiana University! In many courses we assume that securities can be issued/acquired without any real effort or expense. The reality is that trading securities has more costs than just merely brokerage commissions. Security trading is complex enough to justify devoting an entire course to it and we will still cover only a portion of the relevant issues. This field of study is known as “market microstructure.” Microstructure has grown rapidly into one of the largest subdisciplines of finance and has had a profound impact on the real world. For example, a 1994 research study by two university professors uncovered evidence of implicit collusion by NASDAQ dealers. This led to a class action lawsuit that was eventually settled when 30 brokerage firms paid a total of $1 billion in damages!




There are three main goals for students in this course:


1.       To develop a fundamental knowledge of how security trading is conducted, how security traders can minimize their cost of trading, and of how market makers can optimally set prices and execute orders.


2.       To gain first-hand experience in trading simulated securities and making a market for simulated securities.


3.       To develop group communications skills and report exposition skills by actively practicing these skills.




My approach to teaching involves two key features:


1.    Assignment Preparation. Prior to each class session students are expected to complete a reading assignment and vote their opinion on key issues. Students can vote by going to the course web site and clicking on the relevant vote from the course syllabus. Students are free to complete some or all of them in groups. To count, votes must be completed by noon on the day of class.

2.    Class Participation. Students are expected to play a primary role in explaining the assigned readings, expressing their opinions, asking questions, and contributing to the class discussion. This “active learning” approach is student-centered, as opposed to professor-centered (where the professor simply lectures). This approach is intended to create a more stimulating learning environment and provide students an opportunity to practice their communication skills, which are essential ingredient for a success business. Cold calling will routinely be used to insure that everyone participates. But equally important to class participation is your voluntary contributions, such as comments, answers, follow-up questions, and so on. All forms of class participation will be noted for grading purposes, excluding responses where the student is clearly unprepared or voluntary contributions that are clearly not helpful (just “hot air”). Staying current with the assignment preparation makes class participation easy to do and satisfying. Moreover, proper preparation will benefit you by minimizing the need for “cramming” before exams.




Nearly all of the readings have been bundled together in a coursepack, which is available now at TIS bookstore. Just ask for the F535 coursepack. A few readings come from a recent book "Trading and Exchanges" by Professor Larry Harris. Several copies of this book are available at the reserve desk in the Bus/SPEA library under the F535 listing.







Kick Off

Due Date


·         Votes

·         Verbal contribution


20 points

40 points










Group Project #1 Security Trader Optimal Order Submission Strategies

·         Security Trader Competition

·         Written Report



20 points

40 points





Jan 21


Feb 6


Group Project #2 Dealer Optimal Quote and Execution Strategies

·         Dealer Competition

·         Written Report



20 points

40 points








Feb 27



Final Exam

120 points




Total Points

300 points







1.       Every effort will be follow the schedule; however it may be necessary to make small adjustments.

2.       Students are expected to be ready for class at the scheduled time. Classes will start class on time and late arrivals will be frowned on. This policy avoids the problem of having people wander in late and not being able to pick up what is being discussed or even worse disrupting the learning of those who showed up on time.

3.       The lists of learning objectives and the broad critical thinking questions suggest the types of questions that will be on the final. I encourage you to use the lists as a study guides.

4.       During the semester confidential peer evaluations of individual contributions to team projects will conducted. Individuals who have contributed significantly more or significantly less than their teammates will be rewarded or penalized accordingly. The purpose of the peer evaluations is to provide direct incentives for individual contributions on the team projects and assignments.





Classroom Activities                         Assignment Preparation            Web Links

(1.) Jan 14, Introduction

·         Syllabus

·         Trading Stories

·         Buy Side Vs. Sell Side

·         Photographs



·         Harris (2002), pg 11-19, 32-35, 38, 44-57, 62

·         Vote1

Major financial news sites:

CBS MarketWatch


FT Investor (Financial Times)

MSN Money (CNBC)
Yahoo! Finance

Cool view of trading:

Live!charts at Lycos Finance



Classroom Activities                 Assignment Preparation                      Web Links

(2.) Jan 16, Orders and Market Structure

·         Market Orders

·         Limit Orders

·         Demo of ECN 3D limit order book

·         Validity, Expiration, and Other Instructions

·         Quote-Driven Markets, Order-Driven Markets, Brokered Markets, Hybrid Markets

·         International Survey of Trading Mechanisms



·         Harris (2002), pg 68-78, 82-86, 89-96, 101-102

·         Jain (2002a), cover, tables 1-4

·         Vote2

Use Market Orders and Limit Orders to Trade Securities based on Political & Economic Events:

Iowa Electronic Markets


Global Stock Exchanges:

Links for more than 100 Stock Exchanges Around The World

(3.) Jan 21, Limit Order Book Vs. Call Markets

·         Kickoff Group Project #1

·         Uniform Pricing Rule and Single Price Auctions

·         Discriminatory Pricing Rule and Continuous Two-Sided Auctions

·         Exercise in Limit Order Book vs. Call Markets



·         Handout: Group Project #1

·         Harris (2002), pg 116-129

·         Handout: Examples of Limit Order Book and Call Markets

·         Vote3


Real-time, 3D consolidated LOB of 5 leading ECNs:

Consolidated ECN LOB

(4.) Jan 23, Paris, Tokyo, and London

·         Paris Bourse / Euronext trading mechanism

·         Tokyo Stock Exchange trading mechanism

·         London trading mechanism before 1997 and after 1997



·         Biais, Hillion, and Spatt (1995), pg 1655, 1659-1662, 1665, 1671

·         Euronext (2000), pg 1-2

·         Euronext (2000), pg 1

·         Hamao and Hasbrouck (1995), pg 849, 851-859, 864

·         Associated Press Article (4/30/1999)

·         Hansch, Naik, and Viswanathan (1998), pg 1653-1654

·         Ellul (2001), pg 1, 5-9

·         Vote4

Leading Global Exchanges:


Tokyo Stock Exchange

London Stock Exchange

(5.) Jan 28 Recent Structural Changes

·         Impact of SEC order handling rules

·         Impact of decimalization

·         Trading meets the Millennium


·         Barclay, Christie, Harris, Kandel, and Schultz (1999), pg 4-10, 12-13, 15, 26

·         Chakravarty, Harris, and Wood (2001), cover, pg 3-9

·         Jennings (2001), pg 1-5

·         Carroll, Lux, and Schack (2000), pg 36-42

·         Vote5


Recent Developments in Trading:
Financial Information Forum



Classroom Activities                  Assignment Preparation                        Web Links

(6.) Jan 30, Inventory Management

·         Dealer inventory and the liquidity spectrum

·         NYSE specialist inventory

·         FX dealer inventory


·         Grossman and Miller (1988), pg 617-622

·         Hasbrouch and Sofianos (1993), pg 1565, 1568-1573

·         Lyons (1998), pg 1-3, 6-10

·         Vote6

Forex Trading:
GCI Capital Ltd

Global Forex
PFG Forex


(7.) Feb 4, Insider Trading

·         Video: The case of Johnathan Lebed

·         The law and investigation of insider trading

·         Costs and benefits of insider trading

·         Insider trading in Mexico

·         Laws and enforcement around the world



·         Harris (2002), pg 584-587, 591-595

·         Bhattacharya, Daouk, Jorgenson, and Kehr (2000), pg 69-70,73-74, 82-83, 93

·         Bhattacharya and Daouk (2002), pg 75, 80-84, 89, 92-93

·         Vote7


15 year old stock manipulator:

The complete "Next" story on Jonathan Lebed


Enforcement Activity:

NYSE Market Surveillance Unit

NASDAQ Market Watch


(8.) Feb 6

·         Security Trader Competition (bring your computer to class)




(9.) Feb 11, Competition / Integration in Options

·         Kickoff Group Project #2

·         Multiple Listing and Designated Primary MarketMaker (DPM): Pre-reform Evidence

·         Post-reform Execution Performance

·         Does a National Market System exist?


·         Handout: Group Project #2

·         Mayhew (2002), 931, 933-934, 948-949, 955

·         Hansch and Hatheway (2001), pg 0-1, 6-8, Tables 3-4, Figure 1

·         Battalio, Hatch, and Jennings (2001), pg 1-6, 40-41, 44, 46-47, 56

·         Vote9

US Options Exchanges:

American Stock Exchange,

Chicago Board Options Exchange,

Pacific Exchange,

Philadelphia Stock Exchange,

International Securities Exchange



Classroom Activities                      Assignment Preparation                            Web Links

(10.) Feb 13, Day Traders

·         What day traders do

·         NASAA findings and recommendations

·         The case of Mark Barton

·         Trading is hazardous to your wealth



·         McMillian (1999), first four pages and last page

·         NASAA Report (1999), Two covers, pg 1, 9-13, 44-46

·         Wall Street Journal Article (8/2/1999)

·         Barber and Odean (2000), pg 773-776

·         Vote10


Day Trading Firms (Warning: may be hazardous to your wealth!)

Castle Online
MaxTrade Financial Services Pacific Online Trading

Sutton Online, Inc.
Terra Nova Online TradeScape.Com

(11.) Feb 18, NASDAQ Implicit Collusion Trial

The Plantiffs: Security traders who traded in NASDAQ securities

The Defendants: NASDAQ dealers

The Charge: Implicit collusion to create and maintain excessively wide spreads

The Jury: The entire class


·         Price clustering

·         Odd-eighth avoidance

·         Response to adverse publicity

·         The defendant’s view

·         Jury verdict: Guilty or not guilty?


Independent Expert Witnesses:

·         Harris (1991), pg 389-395

·         Simaan, Weaver, and Whitcomb (1998), pg 11

·         Chakravarty, Harris, and Wood (2001), table 4

Witnesses for the Plantiffs:

·         Christie and Schultz (1994), pg 1813-1825

·         Ingebretsen (2002), pg 116-117

·         Wall Street Journal Article 5/27/94

·         Christie, Harris, and Schultz (1994), pg 1841, 1846-1855

Witness for the Defendants:

·         Woodward (1997), pg 0-11

·         Vote11

Info on NASDAQ market making:





Classroom Activities                Assignment Preparation                         Web Links

(12.) Feb 20, New Ways To Trade

·         Wholesale trading of large package trades

·         Optimark

·         Primex Auction


·         Kavajecz and Keim (2002), cover, abstract, pg 1-9, table 1-4, figure 1

·         Optimark Materials

·         Primex Auction Materials

·         Vote12

Trading Innovators:


Primex Auction

(13.) Feb 25, New Trading Systems

·         NYSE's OpenBook

·         NASDAQ's SuperMontage

·         ATSs



·         Boehmer, Saar, and Yu (2002), cover, pg 1-7, table 1-3

·         NASDAQ’s SuperMontage

·         Moszkowski, Gutierrez, and Clark (1999), pg 1-15

·          Vote13



Island, Archipelago, Redibook, Brut, NexTrade, Bloomberg Tradebook, Attain


(14.) Feb 27

·         Dealer Competition (bring your computer to class)




(15.) Final Exam

·         Final Exam = T.B.A.







We will kickoff group project #2 on Jan 21th. Students will be organized into teams and each team will download a security trading simulation based on the Excel add-in program @RISK. Teams can analyze a variety of security trading problems. For example, one type of problem requires that a certain number of shares is desired to be purchased within a particular timeframe. In implementing this request, the general goal is to minimize the utility cost of trading = total cost of trading on shares purchased + (penalty coefficient) * (shares not purchased within the timeframe). Teams will use their own intuition to search for an optimal order submission strategy (order type, size, and price, pattern over time, etc.) for each problem. Security trading problems can vary based on security trader type, degree of trader patience, magnitude of trader penalty cost for execution failure, performance metric, and stock that is being traded. Each team’s order submission strategies will be put to the test in a live, head-to-head, security trading competition on Feb 6 and each team will summarize their security trader strategies in a written report.




We will kickoff group project #1 on Feb 11th. Students will be organized into teams and each team will download a dealer simulation based on a pure dealer market (similar to (pre-reform) NASDAQ or the London Stock Exchange). Teams can analyze a variety of dealer problems. Teams will manage the strategy of one dealer in competition with other dealers. The overall goal is to maximize profits and control inventory risk. Teams will search for an optimal dealer strategy (quote prices and depths, execute large orders in full or partial, adjust to order arrival patterns, adjust to information arrival, and manage inventory) for each problem. Dealer problems can vary based on dealer risk aversion and security volume of trade. Each team’s dealer strategies will be put to the test in a live, head-to-head, dealer competition on Feb 27th and each team will summarize their dealer strategies in a written report.



Learning Objectives

(1.) Introduction

¨       Define the bid, ask, spread, and BBO.

¨       Determine the BBO prices and depths given quotes from various exchanges.

¨       Explain what participants are on the buy side vs. the sell side.

(2.) Orders and Market Structure

¨       Explain the major order types and their key properties.

¨       Know the terms to describe limit price placement.

¨       Who supplies liquidity in a pure quote-driven market, a pure order-driven market, a hybrid market, and a 

          brokered market.

¨       Compare the performance of pure LOB vs. Hybrid vs. Dealer-emphasis systems.

(3.) Limit Order Book Vs. Call Markets

¨       Describe various order precedence rules.

¨       For a given set of orders, work out the limit price placement, trades, quotes, and changes in the limit order

          book for: (1) a limit order book market and (2) a call market.

(4.) Paris, Tokyo, and London

¨       Describe the trading mechanism of the Paris Bourse / Euronext.

¨       Describe the trading mechanism of the Tokyo Stock Exchange.

¨       Describe the trading mechanism of the London Stock Exchange pre & post 1997.

(5.) Recent Structural Changes

¨       The main impacts of the 1997 SEC-mandated reforms.

¨       The main impacts of the 2001 SEC-mandated decimalization.

¨       Explain ECN, demutualizing, after-hours trading, CLOB, Super Montage.

(6.) Inventory Management

¨       Significance of the inventory problem along the liquidity spectrum.

¨       Why dealers want to manage their inventories and how they do it.

¨       Compare the average dealer volume, average dealer profit, and inventory half-life of FX vs. equity.

(7.) Insider Trading

¨       What is insider trading?

¨       What are the costs and benefits of prohibiting insider trading?

¨       The main findings of Bhattacharya et al about the Mexican market.

¨       The main findings of Bhattacharya and Daouk about the world.

(9.) Competition / Integration in Options

¨       Define multiple listing, DPM, NMS, crossed, locked, trade-through.

¨       Discuss the impact of multiple listing and DPM on market performance.

¨       Explain how the options markets have changed since the summer of 1999

¨       Discuss the evidence that a NMS does or does not exist in options

(10.) Day Traders

¨       Provide arguments that the day trader training business is legitimate or not.

¨       What degree of success have day traders actually had?

¨       Describe behavior finance evidence that trading is hazardous to your wealth.

(11.) NASDAQ Implicit Collusion Trial

¨       What is price clustering and how pervasive is it?

¨       Highlight the main points against the NASDAQ dealers.

¨       Highlight the main points in favor of the NASDAQ dealers.

(12.) New Ways To Trade

¨       Explain how trades are packaged, how transparent they are, and why there are gains.

¨       Explain how Optimark works and their new “three-dimensional” orders.

¨       Explain how the Primex Auction system works.

(13.) New Trading Systems

¨       Describe the main impacts of NYSE OpenBook.

¨       Describe the main impacts of NASDAQ SuperMontage.

¨       In your opinion, are the future prospects for ATSs positive or negative? Justify your answer.



  1. Compare and contrast the benefits of alternative trading mechanisms.
  2. What trading mechanism would you recommend to organizers of a new exchange?
  3. Summarize the principles of optimal market making strategies.
  4. Compare the benefits to society of having liquidity provided by risk averse, professional dealers vs. amateur limit order traders.
  5. Summarize the principles of optimal security trading strategies.
  6. Compare and contrast business (order desk) security trading strategies vs. personal (for individual like you) security trading strategies.
  7. How are optimal security trading strategies effected by differing trading mechanisms?
  8. What would you envision as the "ultimate" (best) exchange ten or twenty years from now?

Additional Web Links

Crossing System:

News for Money Managers:
Investment News
Pensions and Investments Online
Leading On-line Brokers:   


Charles Schwab




Quick & Reilly
TD Waterhouse


Leading Traditional Brokers:

DB Alex Brown

Merrill Lynch

Morgan Stanley

Prudential Financial

Salomon Smith Barney

UBS Paine Webber
Wells Fargo Investments


Specialist Firms on the NYSE:

Fleet Specialist, Inc.  

LaBranche & Co. LLC

Performance Specialist Group

Spear Leeds & Kellogg Specialists

Susquehanna Specialists, Inc.

Van Der Moolen Specialists

Wagner Stott Bear Specialists
Walter N. Frank & Co.

Arbitrage Statistics:

NYSE Program Trading Statistics


Arbitrage Firms:

Susquehanna Partners



Leading Investment Banks:

Bankers Trust

Brown Brother Harriman & Co.

CIBC Wood Gundy

CS First Boston

Deutsche Bank

Goldman Sachs

Hambrecht & Quist


JP Morgan

Merrill Lynch

Montgomery Securities

Morgan Stanley

Nikko Securities

Piper Jaffray

Salomon Smith Barney

Sanford C. Bernstein
UBS Paine Webber


Disclosure Data Aggregators:

TAG Audit

Market Systems Inc.






Long-run View of U.S. Finance:

Museum of American Financial History


Volatility Indexes:


Mutual Fund Performance Ratings:


S&P's Fund Services



Global 24-hour trading in stocks:

Nine exchanges in three time zones try to create 24-hour trading in a "Global Equity Market"

Explosive growth in ETFs


Converting Bond Trading From Phone To Electronic: