Just as floor traders concentrate the bulk of their share volume in a relatively small number of the stocks in which they trade,454 they also concentrate a high proportion of their share balances in a relatively small number of stock days. Thus, over the 3 weeks they posted stock day share balances of 500 or more shares in only 675, or 30 percent, of the 2,274 stock days in which they participated, but these balances accounted for 83 percent of their total stock-day share balances over the 3 weeks (table VI-71).45

The stock-day share balances of less than 500 shares posted by floor traders over the 3 weeks were about equally distributed between those that were with and those that were against daily price trends. Balances of 500 shares or more, however, were posted more frequently with than against price trends. Moreover, as the following table indicates, when the size of the balances was 1,000 shares or more, there was an even higher percentage of stock days with the trend than in the case of balances between 500-999 shares.

TABLE VI-n.-Relationship of floor traders' stock day balances to stock day price trends1

* Includes stock days of no price change and stock days of zero balances.

Not only was there a relationship between the direction of the price trend and the size of floor trader balances, but there was also a relationship between the size of the price change and the size of balances. This latter relationship is seen in the following table, which shows the statistical correlation between stock day price changes and floor traders' stock day balances, as well as a statistical measure of the probability of the indicated correlation occurring by chance.

454 See sec. 2.c, above.

455 Floor trader stock day share balances (including purchase and sale balances, both with and against price trends) totaled 1,458,688 shares over the 3 weeks (table VI-71).

TABLE VI-0.-Correlation1 between floor traders' stock day balances and stock day price changes

1 The correlation, which was computed on the basis of paired observations, using a computer, determined the extent to which price trends were related, in size and direction, with floor trader balances.

This statistical probability is measured by the F ratio, a standard statistical test used to measure the reliability of a coefficient of correlation. For balances between 0 to 499 shares, the ratio is 0.30, too small to have any statistical significance. For balances between 500-999 shares, the F ratio is 4.34, which is statistically significant at the 5-percent level; this means that the probability of such a correlation occurring by chance was less than 5 out of 100. For balances of 1,000 shares and over, the F ratio is 11.24, which is statistically significant at the one-tenth of 1 percent level, indicating that the probability of such a correlation occurring by chance is less than 1 out of 1,000. The overall correlation was similarly significant at the one-tenth of 1 percent level.

For balances of less than 500 shares, no statistically significant correlation exists. As the size of share balances increases, however, the correlation becomes larger and statistically significant. For balances of 1,000 shares and over, the correlation is highly significant; that is, the probability of such a correlation occurring by chance is extremely small. Although the correlation is not a strong one, it substantiates the tendency of floor traders to trade with price movements, particularly as the size of balances increases.

Overall, floor traders traded with the trend on more stock days than they traded against it (938 to 838), posted larger share balances with than against the trend (761,610 to 471,988), and showed a positive correlation between the size and direction of stock-day balances and the size and direction of stock day price trends. In short, it is clear that floor traders tend to trade with price trends, and that this tendency is particularly conspicuous with respect to their larger stock day balances which may be expected to have the greater impact on price

movements.

Prior studies by the Commission and the Division of Trading and Exchanges are consistent with this analysis of floor trading. In January of 1945 the Commission released a report on floor trading prepared by the Division of Trading and Exchanges.456 A significant portion of this report ("1945 Report") consisted of detailed studies of floor trading in individual stocks or small groups of stocks, for periods ranging from one trading session to 12 weeks. Most detailed was a study of floor trading in five low-priced automobile stocks during the spring and summer of 1944. This study constituted an investigation into the reasons for sporadic bursts of volume and concurrent price movements of unusual range in these stocks. Records of member and nonmember transactions during these periods were obtained, a sample cross section of public buyers was interviewed, and a compilation was made of rumors concerning these stocks which had appeared in public print. One brief segment of the report, which is representative of the materials compiled for the five stocks, related the following facts with respect to trading in Graham-Paige Motors

450 SEC, "Report to the Commission by the Trading and Exchange Division on Floor Trading," Jan. 15, 1945. (Hereafter cited as "1945 Report.")

Corp. during the first week of August, when the price rose from 2% to 7 and closed at 62. On August 1 the stock acted normally until 5 minutes prior to the 3 p.m. close, the public trading approximately 7,600 shares and floor traders purchasing 600 shares, all at 2%. Between 2:55 and 3 p.m., 29,500 shares were traded, and of these specialists bought 8,000 at 3 and floor traders bought 8,400 at 3, purchases which almost equaled the approximately 10,000 shares purchased by floor traders for the entire month of July. During the first half hour's trading on August 2, floor traders purchased 30,600 of the 59,100 shares traded, and the price moved to 3%. The price fluctuated between 3% and 34 for the remainder of the day, with floor traders purchasing a total of 27,400 shares while selling 17,200 out of a total trading volume of approximately 131,000 shares. Floor trader purchases again exceeded their sales on August 3 as the price moved to 35%, and floor trader holdings reached 46,350 shares, up more than 42,000 shares from July 31. A record volume of over 190,000 shares was set on August 4 by extraordinary public buying, and floor traders sold 35,000 shares on balance as the price reached 45% and reacted to 4. On August 7, the next trading day, floor traders sold 10,900 shares on balance as the stock opened at 7 and closed at 611⁄2 on a total volume of over 170,000 shares. Of the 56 public buyers of this stock who were asked for their reasons for buying, 26 gave "market activity" or "ticker tape action" as their reason, indicating that the price movement was accentuated directly by the trading of floor traders, and as well by the trading of other investors attracted by the floor traders.

Based on this and similar studies the report concluded that the evidence:

simply demonstrates in greater detail what less extensive studies by the Commission had already plainly indicated. In the course of its enforcement of the antimanipulative sections of the Securities Exchange Act, the Commission had frequently traced spectacular price movements and unusual volumes to the activities of members on the floor. Cases of this kind in the Commission's files cover the entire 10-year span since the passage of the Securities Exchange Act. 457

The report went on to recommend the abolition of floor trading. The response of the Exchange to this recommendation, treated below, included having Cole, Hoisington & Co., an independent engineering firm, prepare a rebuttal report ("Exchange Report") in defense of floor trading. Highly critical of the Division's statistical methods, this report nonetheless conceded:

In concluding our comments upon the Division's report of January 15, 1945, we wish to restate that we are in agreement with the conclusion that, in certain low-priced motor stocks last summer, floor trading was conducted in a manner and degree, which, on some occasions, were not in the public interest. We believe that practical methods, short of complete abolition of floor trading, can and should be devised and made effective, so as to preclude a repetition of comparable situations.159

Subsequent studies by the Division, a few of which are noted in appendix H.5, have revealed numerous situations where floor traders concentrated their activities in volatile price situations. The most recent full scale study of floor trading on the NYSE by the Division occurred in 1959. It was there noted:

457 Id. at p. 29.

458 Cole, Hoisington & Co., "Report to the New York Stock Exchange on Floor Trad ag,” p. 39 (May 3, 1945). (Hereinafter cited as "Exchange Report.")

An analysis of trading in American Motors during a 2-week period in October 1958 reveals that under the present restrictions on the Exchange floor traders were able to accentuate price movements and at times to dominate the market. This analysis shows that during a selected 2-week period floor traders were responsible for 10.1 percent of the volume in the stock; that for certain 2-hour periods floor traders were responsible for 25 percent of the volume of purchases or sales; and that for certain shorter periods floor traders appeared to have dominated the market. The analysis found that 15 members were responsible for 82 percent of all floor trading in American Motors during the 2-week period. During certain periods it was found that floor traders bought heavily at the beginning of a sharp price rise and then liquidated their positions at or near the peak of the rise.*

459

Several of the specialists interviewed by the Special Study confirmed the fact that floor traders trade with price trends. One specialist, formerly the chairman of the NYSE board, when asked whether floor traders trade in a stabilizing fashion in a bull market, noted: "They trade the trend a lot. Whether they make stabilizing bids or offers, I wouldn't know." 460 Another specialist and former chairman testified as follows:

Q. When the price of Brunswick is going up, let us say, do you find that most floor traders are buying or selling?

A. They will be buying if they care to last.

A third specialist, asked whether floor trading is "generally with the prevailing trend" in the stock traded, replied: "You could say usually, but some of them might buck it, some of them might go against it."

Edwin H. Stern, one of the most active floor traders on the Exchange and a member of the board of governors of the Exchange, was asked to state his view on whether any of the floor trading rules "should be changed in any respect." He replied:

I would say that the only recommendation that I would make, and this * has not been well thought out at all, but in the areas of increased stabilization, so that at all times, floor traders had at least half of their trades stabilizing trades.

Although this statement apparently refers to stablization in terms of "tick" standards rather than "net balance" standards, it is significant that one of the most important floor traders recognizes that floor trading poses a present problem in the area of stabilization.

It is clear, and indeed confirmed by various members of the Exchange, that floor traders tend to trade with price movements, thereby accentuating price movements. One specialist, questioned in formal proceedings by the Exchange as to his handling of the stock of American Telephone & Telegraph Co., expressed this view perhaps

459 See app. VI-H.5.c.

400 The distinction drawn here between trading with the trend and making stabilizing bids and offers reflects the existence of two distinct systems for measuring the effect floor trading has on price movements--(1) net balance studies, and (2) "tick" studies. According to the "tick" approach, a purchase or sale is considered to be stabilizing or destabilizing according to its relationship to the preceding transaction in the stock involved. A purchase at a price lower than the preceding transaction is considered to be stabilizing, while a purchase at a price higher than the preceding transaction is deemed to be destabilizing. Conversely, a "plus tick" sale and a "minus tick" sale are considered stabilizing and destabilizing respectively. Purchases or sales at the same price as the preceding transaction (“zero-plus tick" or "zero-minus tick" purchases or sales depending on the last different preceding price) are considered to be indirectly stabilizing or destabilizing in the same fashion." The respective merits of the net balance and "tick" approaches to stabilization are treated in detail in pt. D, above, and again-brieflybelow.

more clearly than any other. In a letter to the Exchange he noted: "*** I cannot stress too strongly that, at the present time, Telephone has become a speculative electronic stock, attracting more traders, both floor and office, with consequently more erratic moves."

4. DEFENSES OF FLOOR TRADING

The justifications of floor trading that are frequently advanced are that it contributes (1) liquidity, (2) continuity, and (3) stability to the market.

a. Market liquidity

The defense of floor trading most commonly raised is that it increases the liquidity or "marketability" of stocks by increasing the number of individuals engaged in trading. As a general proposition, permitting members to trade on the floor in all probability does encourage some trading that would not be attempted off the floor, thereby adding to the liquidity of the market. A closer look at this defense of floor trading, however, reveals three reasons why this added liquidity is of limited value: (1) It vests largely in the active stocks rather than in the inactive stocks where it is most needed, (2) it tends to develop primarily on the buy side or the sell side in a manner that accentuates the imbalance of buyers and sellers, and (3) it disappears when it is needed most. As expressed by the Segregation Report:

[F]loor trading, as disclosed by the evidence, reveals a tendency, on the average, both to concentrate in stocks where activity is already present and to accentuate price trends. The liquidity it creates is too often superfluous. It misleads, for under stress it vanishes.

That floor trading, 26 years after the Segregation Report, still concentrates in the active stocks and tends to accentuate price movements has already been shown. This fact severely diminishes the value of the liquidity added by floor traders to the market. The specialists who testified felt, nonetheless, that this liquidity is useful. One, for instance, testified:

Q. *** [A] really inactive stock has no attraction for a floor trader?
A. That's right.

Q. Do you think that floor traders are in any way helpful to the market?
A. Yes.

I think, particularly, when the stock is they will keep things very, very close * * *

Q. But they tend, as you say, to concentrate their activity in the more active stocks?

A. That is right. They want a stock where there is something doing.

Q. But those are the stocks which are pretty liquid already?

A. I guess you have to say they are; yes. It is like everything else. I think the floor traders do a certain amount of good, because they make a good market. Another specialist, a former chairman, testified:

A. Any liquidity or any volume in a stock adds to the public interest, in my opinion. Take Polaroid today, when it is active. A buyer or seller can buy or sell a lot of stock within a very short range.

Q. Do you think it is in the public interest to add to liquidity, volume and public speculation, at times during a period of wild bull markets?

461 Segregation Report at p. 110.