Operating efficiency is when investors can buy and sell in a market at a fair cost. This can vary for different investors, with fixed commission charges benefiting some but not others. Technology and regulation changes can improve efficiency by lowering costs and expanding participation.
Sometimes referred to as an efficient internal market, operating efficiency is a situation within a market where investors buying and selling in that market can do so at a cost that is considered fair to those investors. This kind of allocation efficiency really helps move the market forward, as it helps ensure that everyone who participates in that market is satisfied with the costs they incur as a result of their decision to participate. It is important to note that a market may be considered efficient by some types of investors, but considered highly inefficient by others.
An example of how trading efficiency works in the market is to consider a market in which the commission charged for transactions was at a fixed rate, rather than based on the number of shares involved in the trade. For investors who prefer to buy and sell in large blocks of shares, this fixed charge works very well, much more so than a charge based on the number of shares. For these investors, the operating efficiency of the market would be perceived as quite high. As a result, they will be required to execute more trades on a regular basis, stimulating the market.
At the same time, this fixed commission charge could inhibit investment activity among smaller investors. Since these investors are more likely to participate in trades involving odd lots or lots of securities that are less than one hundred shares, or to purchase several even lots of one hundred shares, there are no cost savings in commission to motivate them to participate in the trade. more frequent trade. Since the cost of trading is not as attractive as it would be if a floating commission based on the number of shares involved were the norm, smaller investors would likely find the operating efficiency of the market somewhat low.
One of the effects of technology and the ability to execute trades online is that trading fees and commissions are much lower than in the past. This means that smaller investors can sometimes take trades where the costs are seen to be in line with the perceived benefits of taking the trade. To some extent, this has helped improve the operating efficiencies of many investment markets, as lower fees allow more investors of all sizes and types to actively participate without incurring costs they view as unfair.
Changes in regulations can sometimes have the effect of improving the operational efficiency of the market. An example is the actions taken in 2000 by the Commodity Futures Trading Commission in the United States. A new resolution passed by the CFTC makes it possible for money market funds to meet margin requirements, where once only cash was considered eligible. While this change went unnoticed by many investors, it had the effect of increasing the operating efficiency of the futures markets by lowering the costs of buying and selling in those markets.
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