Trade execution and volatility usually rank high for a majority of stock market participants, including day traders.

In fact, in the past couple of years, traders have witnessed increased stock market volatility which has certainly increased their curiosity about how stock exchanges work.

One of the most notable events that made an impact was this year’s (2021) meme-stock mania which saw many retail traders either making the biggest wins or incurring massive losses in a day.

It also badly damaged quite a few hedge funds, including Light Street Capital and Melvin Capital.

The meme-stock mania and the wild swings Wall Street experienced during the early days of the Covid-19 pandemic have sparked a period of awareness among traders about how stock brokerages execute their trades.

And, of course, this has brought the question of whether it is best to trade with a traditional stock exchange or an alternative trading system (ATS).

But what exactly is an alternative trading system? In this article, we explain in detail what an ATS is and how it works.

What is an alternative trading system?

Alternative trading systems are privately-owned computer networks that match buyers and sellers of securities and execute transactions without relying on the services of traditional exchanges or brokers.

The term alternative trading system is used in the U.S. and Canada, while in Europe and other nations around the world, an ATS is referred to as a multilateral trading facility.

The term alternative trading system (ATS) is used in the U.S. and Canada to refer to an used to match orders from buyers and sellers of securities by using predetermined and established methods or rules.

Alternative trading systems run their operations parallel to and in competition with old or traditional exchanges.

However, an ATS is different from a conventional stock market in that it is regulated by a broker-dealer instead of an exchange.

Before it can begin to match buyers and sellers of securities, this type of trading venue must first be approved by the U.S. Securities and Exchange Commission (SEC).

Many alternative trading systems are commonly known as “dark pools,” because they tend to function in great secrecy.

How ATSs work

An alternative trading system is similar to a stock exchange, but to operate in Canada, it has to be a member of the Investment Industry Regulatory Organization of Canada (IIROC) and be registered as an investment dealer.

These systems only allow traders to trade securities that are already listed on an exchange. However, they may offer more trading hours and a wider range of trading options than the listing exchange.

Alternative trading systems are a result of the rapid technological changes that have revolutionized how traders buy and sell securities such as stocks and options.

As you might have understood by now, an ATS is simply an electronic trading system, which is an alternative to traditional exchanges that face more extensive regulation.

Most ATSs are licensed to operate as broker-dealers instead of exchanges. And under SEC rules, all current alternative trading systems are dark pools.

This means they function as trading systems, which allow users to make buy or sell orders without publicly revealing the price and size of the orders to other traders in the dark pool. The trades are only revealed to the public after execution.

It is worth pointing out that the basic function of ATS is an electronic manifestation of the traditional trading process, where orders would first attempt to be executed internally before being sent to a public exchange.

Examples of ATSs

Some examples of alternative trading systems include call markets, crossing networks, dark pools, and electronic communication networks (ECNs).

ECN is a network or forum that is fully computerized and facilitates the trading of financial securities away from traditional stock exchanges. Stocks and currencies are the main instruments that are traded on these networks.

To trade with an ECN, a trader must subscribe or open an account with a broker that offers direct access trading.

Benefits of an alternative trading system

For years, alternative trading systems have provided liquidity to financial markets. These systems provide an electronic marketplace to create order books and match buyers with sellers.

For example, retail traders may use an ATS to sell private real-estate securities, or an institutional buyer may place a large block sell order.

ATSs can provide increased access to private investment opportunities and support transactions of private securities. Any transaction that’s done in an ATS, including price and order size, is not listed publicly on order books.

One of the advantages of an alternative trading system over a normal stock exchange is that when using it to trade huge volumes, anonymous pricing does not distort the market price as with normal stock exchanges.

Moreover, ATSs cut out the middleman and this can significantly lower trading costs and provide traders with better information about prices and market conditions.

Oversight concerns

In the long run, competition between alternative trading systems and traditional markets may reduce the cost of trading for traders. However, the growth of these systems raises concerns about market oversight.

Under U.S. securities law, traditional stock exchanges like the NYSE is not just a trading mechanism, but also a regulator. If an exchange is registered with the SEC, it is required to make and enforce rules against market manipulation and fraud, to act in the public interest, and to treat all participants fairly.

But up to now, alternative trading systems haven’t been required to register as exchanges and they continue to operate as broker-dealers.

Accordingly, there have been worries about possible holes in market stability and integrity, investor protection, and the lack of regulatory measures for issues that may pop up in ATS trading.

Bottom Line

Alternative trading systems are non-exchange trading venues that match buy and sell orders. Unlike traditional stock exchanges, ATSs are regulated as broker-dealers instead of an exchange.

Alternative trading systems are essential for institutional traders that want to expedite trades of large blocks of securities to lower the impact that huge public trades may have on the price of a security.

Nonetheless, individual investors and traders can access ATSs indirectly via pension funds, mutual funds, and, in some cases, brokerage companies. In this case, the broker automatically sends the order to the market offering the best price.

All in all, alternative trading systems are used to find counter-parties for transactions.