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THE GENESIS OF AN ORDER TYPE Daniel Aisen Quantitative Developer, IEX March 14, 2015
2008: Internship at RBC
2
Source: h+p://www.wallstreetandtech.com/trading-‐technology/rbc-‐assembles-‐key-‐management-‐team-‐to-‐run-‐e-‐trading/d/d-‐id/1263002?
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
Rob Brad
2009-2011: RBC Electronic Trading
3
• Product: a suite of algorithms to trade large orders in the stock market
• Customer: institutional investors (mutual funds, pension funds, hedge funds, etc.)
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
2009-2011: RBC Electronic Trading
4
• Two types of markets where institutional brokers trade stocks:
1. 11 public exchanges • 60% market share • Publish quotes
2. 40 “private” dark pools • 20% market share • Don’t publish quotes • Derive prices from exchanges
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
2009-2011: RBC Electronic Trading
5
• Focused on two micro-level trading objectives: 1. How to buy/sell as much stock as possible
in a given moment (THOR) 2. How to expose LARGE orders to the
market and have a chance of getting filled without market impact (dark pools)
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
2009-2011: RBC Electronic Trading
6 For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
• Standard use case for a dark pool: midpoint peg order which floats at the average price of buyers and sellers on the exchanges
Source: h+p://www.itg.com/news_events/papers/AdverseSelecRonDarkPools_113009F.pdf
2009-2011: RBC Electronic Trading
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• Two main challenges with resting orders in dark pools: 1. Getting “sniffed out” (market impact) 2. Adverse selection (e.g. buying immediately
before a downtick)
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
2009-2011: RBC Electronic Trading
8 For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
Source: h+p://www.itg.com/news_events/papers/AdverseSelecRonDarkPools_113009F.pdf
2009-2011: RBC Electronic Trading
9
• Two ways a buy order in a dark pool can get adversely selected: 1. Getting “run over” by a larger seller 2. A new seller enters the market elsewhere
at a lower price, creating a brief arbitrage opportunity
• We call the latter structural arbitrage; it only exists because the dark pool can’t update its prices fast enough
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
THERE’S ONLY SO MUCH A BROKER CAN DO
2012: IEX
11 For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
2012: IEX Design
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• Dark pool goal: prevent adverse selection on IEX using a speed bump
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
2013: IEX Build/Launch
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• Goal: prevent adverse selection on IEX
• Launched in October 2013
• Little/no adverse selection for first several months
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
2014: IEX
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• Toward the middle of 2014, as market share grew, so did adverse selection
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
0%
3%
6%
9%
Jan-‐14 Apr-‐14 Jul-‐14
% Res&ng Orders Adversely Selected
Midpoint Peg
2014: IEX
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• Our speed bump was effective at preventing after-the-fact arbitrage
• Orders were now getting adversely selected 1-2 ms before the market moved
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
2014: IEX
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• Potential solutions: 1. Impose stricter throttling 2. Impose fees for exceeding order/trade
ratio thresholds 3. Turn off those customers
• These target the arbitrage traders, but don’t eliminate the blind spot
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
2014: IEX
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• Key insight: A price change in the market is not a single instantaneous event; it is a coordinated event across all 11 exchanges
• Arbitrageurs were trading while the market was transitioning to a new price
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
USE THE SIGNAL TO PREVENT THE ARBITRAGE
2014: IEX
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• How can IEX keep up with the fastest traders: • Speed bump gives us a head start • Unlike a arbitrage trader, false positives
don’t result in losses • Introduced a new order type called
discretionary peg: • Alternative to midpoint peg • Avoids trading at soon-to-be-stale prices
when market is in transition
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
2014: IEX
20
• Introduced discretionary peg order type in November: • 1-2% drop in fill rate • Adverse selection: 9% -> 3%
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
0%
5%
10%
Jan-‐14 Apr-‐14 Jul-‐14 Oct-‐14 Jan-‐15
% Res&ng Orders Adversely Selected
D-‐Peg Midpoint Peg
2015: IEX
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• Lessons learned: 1. Define and track metrics – we could have
responded sooner 2. Don’t punish the traders; eliminate the
arbitrage opportunity
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
2015: IEX
22
• Final thoughts: • It’s the broker’s job to navigate the market
effectively on behalf of their clients • If an exchange or a dark pool has a blind
spot, not much the broker can do • Can’t blame someone for trying to profit off
an inefficiency; exchanges and dark pools have the responsibility to ensure they don’t have any blind spots
For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
2015: IEX
23 For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.
Source: h+p://www.nyRmes.com/2014/04/06/magazine/flash-‐boys-‐michael-‐lewis.html?_r=0
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