Friday, 29 June 2018

CME patent identifies speculative systems used by speculators

Paul Westmont tweeted a reference to a new CME patent, "Message processing protocol which mitigates optimistic messaging behavior" published on 28th June 2018.

Hot off the press:
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A clever person in Amsterdam examining a gem
This patent identifies a few potential techniques, aka tricks, for optimistically processing on a network to improve your effective latency.

I referred to some of these in the recent "Negative Latency" piece. Some such speculative skills were also discussed a few years ago in my piece originally published by Automated Trader, and subsequently published here once the rights reverted, as, "The accidental HFT firm."

I've pulled out the fun list of the techniques CME explicitly identifies below.

The public view of the trading tradecraft expands.

Speculating on your speculation is stepping up a level.

Happy trading,


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Wednesday, 27 June 2018

IEX updates IEX update

It’s been at least fifteen minutes since I complained about IEX. It must be time for another meander.

IEX starts pricing off the SIP

Mr Brad Katsuyama’s misleading of investors would be amusing if it wasn’t so dangerous. His false and misleading statements have undermined confidence in the US National Market System over the last few years.

Do you remember the classic Lewis, Katsuyama, O’Brien CNBC debate where Mr Katsuyama accused BATS Mr William O’Brien of pricing off the SIP and disadvantaging his customers? Mr O’Brien denied it as it slipped his mind in the heat of the moment the acquired Direct Edge did that. O’Brien was no longer at BATS four months later. Despite Mr Katsuyama’s continued misrepresentations, he remains employed.

Well, IEX has decided to start using the SIP to contribute to its pricing.

File No
Proposed rule change to amend rule 11.410(a) to update the market data source that the Exchange will use to determine the Top of Book quotation for NYSE National in anticipation of its planned re-launch.

… the Exchange proposes to amend and update the table specifying the primary and secondary sources for NYSE National (“XCIS”) in anticipation of the planned re-launch of XCIS on May 21, 2018.9 As proposed, the Exchange will use securities information processor (“SIP”) data, i.e., CQS SIP data for securities reported under the Consolidated Quotation Services and Consolidated Tape Association plans and UTDF SIP data for securities reported under the Nasdaq Unlisted Trading Privileges national market system plan, to determine XCIS Top of Book quotes. No secondary source is proposed to be specified as SIP data will be used exclusively.

Perhaps it’s not that important. In the context of Mr Katsuyama’s misdemeanours, perhaps it is.

I wish IEX would apply their own Rule 3.14.0 to staff, including Mr Katsuyama:

Rule 3.140. False Statements
No Member or applicant for membership, or person associated with a Member or applicant for membership, shall make any false statements or misrepresentations in any application, report or other communication to the Exchange. No Member or person associated with a Member shall make any false statement or misrepresentation to any Exchange committee, officer, the Board or any designated self-regulatory organization in connection with any matter within the jurisdiction of the Exchange.

IEX keeps markets simple by making its pricing more complex

IEX long ago promised to keep order types and pricing simple. This was to ensure your average punter would not be disadvantaged from not understanding the complexity. An admirable goal IEX has failed at. IEX continue to increase complexity making life worse for your average investor.

File No
Proposed rule change to charge a more deterministic fee of $0.0003 per share for executions at or above $1.00 that result from removing liquidity with an order that is executable at the far side of the NBBO.

IEX added a Spread-Crossing Remove Fee at 3 mills, $0.0003 per share, to ameliorate part of the rape and pillage they introduced with the Crumbling Quote Remove Fee Indication of 30 mills. The Crumbling Quote Remove Fee Indicator adds great uncertainty to trading at IEX. You don’t know if you’re going to be hit with a high fee or not. IEX’s crummy crumbling quote voodoo is often wrong causing massive fee charges to appear on your statement for no real reason.

It’s quite terrible you can’t determine the crummy crumbling fee a priori. You can’t even calculate with rigour ex ante.

You get hit with a high fee for a trade. Is it correct? You have no way of knowing as the crummy crumbling quote is dependent on the feeds IEX gets internally within their own parameters of delay, jitter, and determinism, or lack thereof. You can’t deterministically parse chaotic information you don’t have. You can’t check your own fees. Does the SEC check the fees every month? I don’t think so.

IEX had to refund customers for incorrectly charged fees earlier this year. No one knew.

IEX fees - can’t predetermine them, can’t audit them
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At least this new fee introduced is lower than the expensive dark fee you get pinged with if you stumble over a midpoint in the dark.

I did like this line from the fee reasoning on page 14,

Furthermore, the proposed Spread-Crossing Remove Fee is substantially lower than the fee for removing liquidity on competing exchanges with a “maker-taker” fee structure (i.e., that provide a rebate to liquidity adders and charge liquidity removers)

One sided misrepresentation from IEX again. The nett fee IEX takes is much higher than other exchanges. IEX is the expensive dark exchange.

Clarity in pricing

The rules were so clear, IEX had to issue on the 20th June a further update to add clarity to the simple rules they have, effective 1st July. Yes, Minister.

File No
Proposed Rule Change to Modify the Structure of its Fee Schedule and Make Several Conforming and Clarifying Changes, pursuant to IEX Rule 15.110(A) and (C).
Let’s check out the new simple and clear fee structure:

IEX fees - you should check out the fine print
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The fee schedule is quite misleading as for some of your stocks the quote instability charge that you pay may be more likely when the quote is stable rather than when it is unstable, according to their own formulae. If you put it in capitals and pervert the meaning of Quote Instability by subverting its normal definition, thereby turning it into your own proper noun, then you have a a nice marketing message. Science be damned.

IEX aren’t the only offender in the complex pricing stakes, but their impossible to know a priori, or audit ex ante, CQRFI fee takes it to a new level in the market of the absurd.

IEX crumbling quote indicator changes

IEX changed the crumbling quote formulae a while ago as they do from time to time. It is still a bad idea and a bad formula. I think many undergraduates could come up with a better toxin in a few days if they were appropriately directed with the same data. It is what it is:

File No
Proposed rule change to amend Rule 11.190(g) to incrementally optimize and enhance the effectiveness of the quote instability calculation in determining whether a crumbling quote exists.

One funny thing about this update is the sheepish admission by IEX they have been indicating quote instability on one side it is infact the other side of the NBBO that is crumbling. And yes, you will have paid an excessive 30 mill fee for trading on the stable side of the market. You couldn’t make this stuff up if it wasn’t true.

Digest this bit first from page 8,

When the System determines that a quote, either the Protected NBB or the Protected NBO, is unstable, the determination remains in effect at that price level for two (2) milliseconds. The System will only treat one side of the Protected NBBO as unstable in a particular security at any given time

Do you see the problem? The market could step up and then switch back around pretty easily, even in just 100 microseconds. You could end up with a variety of stocks locked into Quote Instability mode on opposite sides of the market for two milliseconds. Crazy stuff, right?

IEX was woken a little from their slumber and decided that if their often false crumbling quote switches around then they will too rather than keeping it locked at the wrong side.

The indicator is still often false, but at least that is something.

IEX describes the changes starting on page eleven,

Rule 11.190(g)(1) provides in part that when the System determines that a quote, either the Protected NBB or the Protected NBO is unstable, the determination remains in effect at that price level for two (2) milliseconds. The Exchange proposes to revise the time limitation on how long each determination remains in effect, and reorganize certain existing rule text for clarity. As proposed, when the System determines that either the Protected NBB or the Protected NBO in a particular security is unstable, the determination remains in effect at that price level for two (2) milliseconds, unless a new determination is made before the end of the two (2) millisecond period. Only one determination may be in effect at any given time for a particular security. A new determination may be made after at least 200 microseconds has elapsed since a preceding determination, or a price change on either side of the Protected NBBO occurs, whichever is first. If a new determination is made, the original determination is no longer in effect. A new determination can be at either the Protected NBB or the Protected NBO and at the same or different price level as the original determination. Based upon our analysis of market data, as described above, the Exchange believes that changes to the time limitation would provide for a more dynamic methodology for quote instability determinations thereby incrementally increasing the accuracy of the formula in predicting a crumbling quote by expanding the scope of the model to additional situations where a crumbling quote exists at a different price point, or again at the same price point within two (2) milliseconds. For example, suppose that the NBBO is currently $10.03 by $10.04 in a particular security, and the System determines that the NBB is unstable. This determination goes into effect, with an expiration time set two (2) milliseconds in the future. Now suppose that one (1) millisecond later, the NBB falls to $10.02 and the System determines that this new NBB is unstable. As proposed once the System makes a new determination that the NBB of $10.02 is unstable, even though the prior determination at $10.03 has not expired, the new determination will overwrite the old determination, and its expiration time will be set to two (2) milliseconds in the future from the time of this determination.

The dark and expensive exchange that should be an ATS and not an exchange, is still deploying some wriggle room chicanery with their 200-microsecond from the proceeding determination thing, which they really shouldn’t need given they have a 350 microsecond delay in their stupid system.

And they have to change some of the variable definitions in their dumbly inaccurate, often false, crumbling quote indicator,

The Exchange proposes to revise five of the quote stability variables currently specified in subparagraph (1)(A)(i)(b) of Rule 11.190(g). Specifically, the Exchange proposes to revise variables NC, EPosPrev, ENegPrev and Delta to be calculated over a time window looking back from the time of calculation to one (1) millisecond ago or the most recent PBBO change on the near side (rather than on either side), whichever happened more recently. Based on our analysis of market data, as described above, the Exchange identified that for each variable, considering the maximum change over the time window defined in this manner is a more accurate indicator of a crumbling quote than the current approach. Similarly, the Exchange proposes to revise variable FC to be calculated over a time window looking back from the time of calculation to one (1) millisecond ago or the most recent PBBO change on the far side (rather than on either side), whichever happened more recently. Based on our analysis of market data, as described above, the Exchange identified that for this variable, considering the maximum change over the time window described in this manner is a more accurate indicator of a crumbling quote than the current approach.

You also have to keep in mind IEX is acting in the future due to their internal lack of 350 microsecond delay implying that one millisecond look-back is really 650 microseconds of look-back from their lack of perspective.

IEX should be forced to change the term from “quote instability” or “quote stability” as that is a clear misrepresentation of the facts and misleading, regardless of their intention.

Thanks again for signing up for our “Stability Operation.” Just because you’ll be losing two perfectly good legs and be confined to a wheelchair doesn’t matter. Many people may need a wheelchair in the future, so we’re enhancing the stability of everyone. No, we don’t think it is at all misleading. Being more stable on a flat surface that takes a wheelchair will be a boon to everyone. Yes, even gymnasts and rock climbers. It was right there in the EULA you clicked the OK button on. Stop complaining. The regulator approved it.

Double squeak from double speak indeed.

Anyhow, just to sound Presidential, here is the new failing, often fake, Quote Instability Factor and friends from the failing IEX’s new logistic regression formula:

Protected Best Offer minus Protected Best Bid
Protected Quotations, Protected NBB, Protected NBO, Protected NBBO
includes quotations from not all of the exchanges, just these ones: XNYS, ARCX, XNGS, XBOS, BATS, BATY, EDGX, EDGA.
  1. N = the number of Protected Quotations on the near side of the market, i.e. Protected NBB for buy orders and Protected NBO for sell orders.
  2. F = the number of Protected Quotations on the far side of the market, i.e. Protected NBO for buy orders and Protected NBB for sell orders.
  1. NC = the number of Protected Quotations on the near side of the market minus the maximum number of Protected Quotations on the near side at any point since one (1) millisecond ago or the most recent PBBO change on the near side, whichever happened more recently.
  2. FC = the number of Protected Quotations on the far side of the market minus the minimum number of Protected Quotations on the far side at any point since one (1) millisecond ago or the most recent PBBO change on the far side, whichever happened more recently.
  3. EPos = a Boolean indicator that equals 1 if the most recent quotation update was a quotation of a protected market joining the near side of the market at the same price.
  4. ENeg = a Boolean indicator that equals 1 if the most recent quotation update was a quotation of a protected market moving away from the near side of market that was previously at the same price.
  5. EPosPrev = a Boolean indicator that equals 1 if the second most recent quotation update was a quotation of a protected market joining the near side of the market at the same price AND the second most recent quotation update occurred since one (1) millisecond ago or the most recent PBBO change on the near side, whichever happened more recently.
  6. ENegPrev = a Boolean indicator that equals 1 if the second most recent quotation update was a quotation of a protected market moving away from the near side of market that was previously at the same price AND the second most recent quotation update occurred since one (1) millisecond ago or the most recent PBBO change on the near side, whichever happened more recently.
  7. Delta = the number of these three (3) venues that moved away from the near side of the market on the same side of the market and were at the same price at any point since one (1) millisecond ago or the most recent PBBO change on the near side, whichever happened more recently: XNGS, EDGX, BATS.

Now, it’s relatively easy to get a feel for what this is doing without thinking too hard. If a DPEG is a buy order and the market’s protected bid quote volume is large, then N is big. The QIF formula will use resulting in one over a big number, which will result in a near zero, or low, number. It will be likely be less than 0.19, IEX’s fake Quote Instability Factor threshold. That is, lots of volume on your side of the market means the market is stable and not in a position that indicates a crumbling quote. Quite natural.

Though please remember when referencing the formulae, now is 350 microseconds into the future, as per the use of non-speed bumped data in a speed bumped exchange.

From the IEX Signal 2.0 whitepaper, IEX told us,

“On our example day of December 15, 2016, our current formula resulted in about 1 million true positives and 975,000 false positives. This new candidate formula would have produced about 2 million true positives and 2.1 million false positives.”

That’s a stupid number of false positives. It is good if you can fleece charge your customers big fat fees when you’re wrong 😇 👀.

How false is this new calibration of the fake indicator? For which stocks? IEX does not tell us. We can be sure that such a synthetic silly sausage shop standard doesn’t fit all stocks the same. QIF will be more fake for some than others. One size does not fill all. The universe of stocks IEX hinders your trading with is broad. For example, liquid and illiquid stocks behave quite differently. Somehow I don’t think you’re suprised.


You may be surprised to hear I’m not a fan of a dark and expensive exchange. Especially one where you can’t work out your fees in advance or even after you’re charged.

IEX impedes price discovery and harms public markets.

Fortunately, despite the harm IEX has done to the NMS, it’s marginal impact is economically small due to its small market share. Unfortunately, the qualitative burden of IEX is large due to the noise and misleading statements from IEX the industry has had to try to counter. The additional execution infrastructure costs the industry has had to bear is wasteful at best. IEX is a frustrating little baby who thinks its soiled nappy is innovation.

All of this for an exchange that leaks information to the well connected trader via both the SIP and significant clients’ holdings. No other exchange comes close to the level of bad latency arbitrage exposed by IEX’s displayed market and dark executions.

IEX also gives a greater advantage to faster traders than other exchanges as it does not have a fair co-location facility. Shorter cables and better positions help.

The SEC should send back IEX to the land of the ATS, where it belongs. There’s no shame in that. Many a good ATS serves a useful purpose. Then, perhaps, we could all get along.

Happy trading,


Monday, 25 June 2018

US Finra ATS tier 1 stats update: June 25 release for June 4

UBS and Credit Suisse remained ensconced at #1 and #2 respectively. Barclays dropped a couple of slots to 6th.

TWEB dropped 8 places to 21st with only 114 trades for the week. The 211,017 shares per trade kept it at around 1% of ATS tier 1. Normal volatility in the rankings for DealerWeb thanks to the small number of trades.

Instinet's second venue, Block-Cross was the biggest mover up in the rankings, popping up 3 slots to 18th. This gives Instinet a solid aggregate top ten viewpoint from their three venues. The menu of Instinet venues has an interesting variety of average trade sizes with 209 shares, 12,049 shares, and 3,925 shares.

Luminex jumped up a slot to 25th after being a topic of conversation last week in "Liquidity Dancing.

Happy trading,


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Saturday, 23 June 2018

Liquidity dancing

Liquidity misconceptions in finance are some of the annoying itches I have wanted to scratch for a while. This is a meander that scratches that itch.

I won’t meander anything newsworthy for most market professionals here. If you’re a professional, I’d save your time. Nevertheless, this may be a reasonable reference to point to if you’re asked about liquidity.

The question of liquidity is very much a question of dance. The point of trading is to engage with another party so that two transactional needs are met. Utility is the goal. Utility is also the gaol5 constraining a liquidity hunter's options. Just as it takes one to provide a cliche for another one to read, it takes two to tango. If your trading friends, or marketplace, do not supply you with liquidity, you have to leave them behind, “Cause your friends don’t dance and if they don’t dance, Well they’re no friends of mine.

Safety Dance1

Marketplaces allow a more efficient risk transfer and price discovery process to take place. Without a marketplace, you are in danger of trading at an unfair price or being not able to trade at all. Despite all the warts of capitalism, markets provide the best way for parties to trade, despite the motivations of the participants.

Generally, none of the participants is trying to help any other participant. They trade for their own interests. The magic of the market is they work despite those motivations. The misunderstanding of this simple fact is the cause of much strangeness and inefficient enterprise in modern markets.

Asset manager versus HFT

Asset managers are wary of HFT firms, particularly private trading firms (PTFs). An asset manager views with suspicion the utility an HFT gains from trading with them. Very few losing days in the HFT bank account seems unnatural. An asset manager feels they are being ripped and feeding this continuous profit the HFT enjoys.

One way for an asset manager to avoid an HFT is to find a marketplace without an HFT. One minor trouble is such venues are difficult to find. Even at IEX the most prolific traders are HFT. If you’re an asset manager trading at IEX it is more likely than not that your counterparty is an HFT. HFTs are prepared to risk more and earn less at the best price which is why they win such trades. Buying low and selling high is still the only way to make money. An HFT is more prepared, in many ways, to roll the trading die. The law of large numbers gives them a good chance of making positive cash-flow every day even if their success rate on your individual trade with them is only 51-55%. The asset manager doesn’t realise there is a fairly high chance the HFT may lose on their individual trade.

But, but, I want to earn that spread…

OK, go build your own marketplace then and see how well that works for you.


A bunch of asset managers get together and decide that they’d be better off without proprietary trading, especially those “nasty” HFT firms.

From Reuters 5th October 2015 story, “Luminex ‘dark pool’ enlists 73 members ahead of trading launch,”

Luminex plans to only allow institutional investors, such as mutual fund companies, to trade on its platform, snubbing the broker dealers and proprietary high-frequency trading firms that own and generate much of the trading in other private trading venues.

Luminex’s 73 subscribers, which are listed on the company’s website, include Vanguard, TIAA-CREF Investment Management, AllianceBernstein, Eaton Vance, Goldman Sachs Asset Management, Greenlight Capital Inc, and J.P. Morgan Investment Management. (

The consortium that owns Luminex and collectively manages 40 percent of U.S. fund assets said it started the trading platform with the aim of lowering transaction costs and eliminating the types of profit driven conflicts of interest that have been seen in some existing venues. Any profits made by Luminex will be invested back into the company to further reduce trading costs.*

The Reuters article implies some motivation may have stemmed from illegal activity such as that from ITG,

Recent enforcement actions involving the trading platforms include a $20.3 million SEC settlement with brokerage firm Investment Technology Group on charges it ran a secret trading desk that profited off of confidential customer information within its dark pool.

Not an unreasonable motivation.

Luminex has recently touted their May 2018 results: “Luminex May 2018 Recap”

Luminex May 2018 Recap
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Wow, that sounds impressive. The $10 Billion traded in a month sounds a big number, doesn’t it? An efficient exchange might make $0.0001 per trade. That is $20,000 per month at an average stock price of $50 for such a Luminex notional size. Not bad but it is not easy to run the technology of an ATS, cope with the regulatory requirements, and pay your staff on such a budget.

The National Market System (NMS) exchanges traded 6,875 billion dollars of notional value for the same period. Luminex traded the equivalent of just 0.15% of the exchanges which is only a partial picture of the liquidity landscape.

Let’s have a look at their tier one stock performance compared to the other thirty odd somewhat odd ATS peers:

Luminex May 2018 Recap
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That doesn’t look so great. The percentage market share of the ATS space is just a paltry 0.45% with a ranking, by volume, of 26th. It’s hard to tell if that record-breaking memo is something to shout about or a job preservation exercise.

Here is a chart of the changing market share landscape in ATS land:

Luminex May 2018 Recap
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That’s right. Luminex is somewhere down there in the noise floor in the bottom of that chart.

What has gone wrong at Luminex? Nothing really. This is my point. They wanted to create a mono-culture client trading pool and succeeded. It is an understandable reaction to the fear that mongers peoples’ minds against HFT and proprietary trading. However, such an enterprise is going to find success a difficulty. Success often requires heterogeneity. Dare I say it? It takes two to tango:

Pearl Baily - Takes two to tango

Luminex looks to have done a good job with admirable enterprise. However, it represents a fundamental misunderstanding of marketplaces and where liquidity comes from.

Asset manager fears

There are several notions of wrong. Firstly, anti-HFT is a misunderstanding of who your competitors are. Your competitors are other asset managers. An asset manager should be worrying more about selling a stock to another asset manager. They both think their opposing actions are a sensible medium or long term solution. Both can’t be right. If you sell to an HFT, both can be right and make money as there is a time arbitrage there.

Not only does such a time difference support an asset manager’s and HFT’s difference in utility, there is a more fundamental aspect to the utility of every trade. Let’s meander through this thought.

Take your passive buy at best that gets traded through. If you’re an asset manager you’ll grumble about being traded through. You’ll imagine it was one of those nasty HFT firms and be pissed off that you could have bought the stock a tick cheaper. However, you’ll be happy as you wanted the trade and shrug your shoulders as, at an average price of $50 today, a tick of one cent is just 0.02%. If you’re in the asset manager game to only make 0.02% on your medium or long term trades please send the investors their money back; you’re in the wrong game. Annoying but not crippling.

If you’re an HFT and you get traded through, that is an existential crisis. Your margins as so thin that if such adverse selection happens too often you’re simply out of business. You have to take the risk and take such trades on the chin to play at all, but this is a careful calibration. The law of large numbers that guarantees your daily profit also guarantees the immediacy of your death if you get such calibrations slightly wrong. It’s a tough game for an HFT.

Such a “traded through” case is quite different for both types of market participants. It is an existential threat to an HFT, and an annoying mosquito bite to an asset manager.

The other case of the trade not happening at all is also quite different for both. For an HFT if their bid does not get lifted, it’s simply a shrug and they move on. For an asset manager it is a huge pain as they want the stock and now they are chasing it higher and not getting their portfolio at the right price. An HFT can feel a bit of that pain if they are long inventory, but it is quite different to the pain the asset manager endures.

Again, we see different utility for the outcomes. Your trade not filled is a shrug for an HFT and quite the pain for the asset manager.

This is what makes a market. Diverse participants with differing views of utility, risk, and trading. More sophisticated traders, such as an HFT, may also offset in different markets or products bringing further diversity to the utility profile beyond the time horizon difference normally considered. More speculation in a market hurts speculators and helps investors.

A clever asset manager would not create a marketplace for just the their own competitors. They would encourage a marketplace with much diversity and competition. This would provide the most efficient price whilst those nasty speculators crush each other with their games.

Imagine you’re an HFT sitting in the market passively. What do you fear most? A big institutional order that trades through your price. That big information stick an institutional investor carries is something to fear.

What do asset managers fear? Many often fear that those pesky HFT firms with their mosquito bites and going to destroy their long term alpha with the spread friction they impede their trading with.

The real truth of the matter is that they shouldn’t fear each other they should fear their own kind. The kind of firm that will put an HFT out of business is another HFT. The kind of asset manager that will destroy another asset manager’s business is an asset manager with better returns, not an HFT firm.

In this context, you may see the fundamental philosophical tension of the Luminex model. I’m only going to allow trading with folks I’m directly competing against, with the same painful utility points on trades, and without a diverse culture of transference between other risk dimensions such as time, product, correlation, covariance, informational understanding, etcetera.

In game theoretic and evolutionary terms, a homogeneous gene pool rarely outperforms the heterogeneous. Perhaps the Luminex experiment shows this. Then again, perhaps having a worse trading pool is OK if you’re psychologically safer. I’m not sure your shareholders would have the same feeling when considering your psychological well-being versus their returns.

Smarter asset managers

If the size of assets under management counts as success, perhaps Vanguard is smarter than your average bear. Here are some historical comments from Vanguard on the issue of competing with HFT reported by Stephen Foley in the FT, “Vanguard chief defends high-frequency trading firms”

Luminex May 2018 Recap
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This wasn’t just a reaction for the Lewis fiction in Flash Boys as you see in this similar comment from September 2010 in Forbes, “Vanguard’s Gus Sauter Thanks High-Frequency Traders”

Sauter said that there might be a small percentage of high-frequency trading that is manipulative, but that overall this is a type of trading that benefits long-term investors like Vanguard’s customers. “Most high-frequency traders in our view are essentially electronic market makers or they’re statistical arbitrage players. In both cases, they’re working to tighten spreads and enhance liquidity. If that’s the case, then we as investors in the marketplace benefit by getting lower transaction costs when we go into the marketplace to invest for the long-term.”

How much of a benefit does Sauter attribute to market developments in the past 15 years, which include decimalization, high-frequency trading, increased fragmentation, Reg. NMS and order handling rules? “We’ve measured our transaction costs and over the past 15 years, they’ve been cut by about 60 percent,” Sauter said. “That results in hundreds of millions of dollars a year in savings to investors in our funds.”

The somewhat biased Modern Market Initiative2, a group that exists to support their private HFT trading members, makes the same points here with commentators not having such bias, “HFT = Cheaper Trading = More Money in Retirement Accounts”:

“Main Street is the great beneficiary … We are better off with high-frequency trading than we are without it.”
– Jack Bogle, Vanguard founder, pioneer of low-cost investing

“Trading has never been easier and costs never lower thanks to human intermediaries being rendered obsolete.”
– Robin Wigglesworth, Financial Times

“In the decade of migration to electronic trading and HFT arrival, transaction cost decreased by over 50% for both retail and institutional investors.”
– Albert J. Menkveld, Professor of Finance, VU University Amsterdam

“By providing so many bids and offers, high frequency trading firms have narrowed pricing spreads. Spreads for almost every financial instrument are substantially less than they were a decade ago. For example, spreads in most US equities are half of what they were 10 years ago.”
– John Servidio and Bo Harvey, McGuireWoods LLP

“From an institutional or buy-side perspective, today’s markets are more efficient than anytime in the past. Today’s markets are faster, they’re cheaper to trade, the typical buy-side desk has more choice due to competition in terms of execution venues, whether they’re block trading systems or dark pools, registered ATSs, and algorithms that we can customize that allow us to navigate electronic markets and obtain the best possible price for our fund shareholders.”
– Bill Baxter, Fidelity’s Head of Global Program Trading and Market Structure

“The world should be measured the following ways: The spread between bid and ask, and the commissions charged to do a transaction, are so dramatically smaller today — they’re measured in thousandths of a penny sometimes compared to when I was in the securities business.”
– Michael Bloomberg, founder and CEO, Bloomberg, LP

“High-frequency trading in general has been good for the retail investor.”
– Fred Tomczyk, CEO, TD Ameritrade

“Overall, HFT enhances market liquidity, reduces trading costs, and makes stock prices more efficient.”
– Charles Jones, Columbia University professor, study analyzing 30 papers on HFT

“[Electronic market making] brings tangible benefits to our clients through tighter spreads”
– BlackRock Viewpoint

“How do we feel about high-frequency trading? We think it helps us.”
– Cliff Asness, Founding Principal, AQR Capital Management

“… the increased use of electronic trading has brought many benefits, such as more efficient execution and lower spreads.”
– Timothy Massad, CFTC Chairman

“Numerous studies – including the recently released UK Foresight HFT project – have shown that transaction costs for both retail and institutional traders decreased substantially with the growth of high-frequency trading.”
– Larry Harris, USC Marshall School of Business, former chief economist at SEC 2002-04

Nevertheless, the fear of HFT persists.

My thesis is that such fears are primarily a misunderstanding of marketplaces and liquidity dancing.

Some liquidity dance misconceptions

Before I meander about what I feel liquidity is, let’s look at some of the itches I wish to scratch.

Providing liquidity versus taking liquidity

This drives me nuts. A trade takes place if there is a willing buyer and seller. Both wish to trade at the price implying an agreement, of sorts, in utility. Both sides provide the liquidity the other side needs. There is no taking of liquidity here. Both sides are providing the other with a service. That service is liquidity at a particular price. The buyer is providing the seller liquidity. The seller is providing the buyer liquidity.

Aggressive and passive are fair enough adjectives but the all too common vernacular of providing or taking liquidity paints an improper picture. Taking liquidity has come to have an unwarranted negative connotation. The aggressor is providing the liquidity sought at the price requested. This is a good thing. Service is provided to both parties. Taking liquidity implies removing the ability to trade at all. This is quite the opposite of enabling a trade. Next time you see or hear the all too frequent term “taking liquidity,” rebel.

Taking liquidity is perhaps better described by someone cancelling an order. The immediate ability to trade with that stock has been lost.

However, it is not really lost. Perhaps just delayed. It still exists which highlights my next point.

Most liquidity lives in peoples’ heads

Exchanges may transact much of activity, but the displayed liquidity is not where most of the liquidity lives. The prior example shows this somewhat as the aggressor is not showing liquidity before they provide it. It may have been either a hidden intention in an algorithm or in a trader’s head.

Liquidity lives in exchanges, visible as lit prices as well as being hidden in the dark folds of the exchange. Liquidity lives in ATSs and other pools. Liquidity lives in brokers internalisation pools and procedures. Liquidity lives in the intention of programmed algorithms’ and models’ automated intentions. Liquidity lives in the people who control stock. It lives in their heads. Most liquidity is in this form.

Earlier this year Barron’s reported, “The U.S. Stock Market Is Now Worth $30 Trillion” with a reference to the Russell 3000 Index, which represents approximately 98.5% of the market’s capitalisation. As noted above, the NMS exchanges traded around $6.875 trillion in May. Even over a month, most stock doesn’t trade. Someone controls whether a parcel of publicly listed stock trades. Again, the liquidity is effectively in that someone’s head. A simple thing we should remind ourselves of from time to time.

HFT pushes people out of the market risking the market itself

If that is what you think, then you are not playing the right game. If you want to trade to earn the bid-ask spread then you need to be an HFT market maker, not a trader in this technological age. The real risks to liquidity in the market are different to what you may think.

A primary liquidity risk is the growth of alternates to publicly listed stocks. To my simple soul, the massive growth in private equity is the number one existential threat to the viability of US public stock markets. Much of the returns accreted by new ventures used to come from a time after they listed. Private equity giants, such as Uber et al, have turned that thinking on its head. Much of the venture returns now exist outside public markets. How significant the disappearance of such a source of alpha from the public markets really is, remains to be seen. I suspect this may get worse before it gets better. It may be one of those one-way doors. Now that the genie is out of the bottle, it may be hard to plug the damned dam wall. Unless you’re one of those qualified investors with enough qualification to be interesting, you may be missing out on funding your retirement. Economic democratisation in the US is in reverse. It’s not just politics looking increasingly totalitarian.

If you haven’t seen the 2015 presentation from A16Z, “U.S. Technology Funding – What’s Going On?”,

Luminex May 2018 Recap
click to enlarge

then I highly recommend it. It has dated a little as some of the giants have returned decent public returns since and there has been an uptick in IPOs, but the basic case still stands. Large private equity is eating returns that used to be available to main street.

Private company growth needs government regulation to prevent government regulation from contributing to the death of investment returns and the happy retirement of perhaps ninety-nine per cent of the population. You really do want to occupy Wall Street.

Passive equity management also largely impedes market liquidity. There is simply less desire to actively trade. That is not only due to index funds but also, perhaps to a lesser extent, due to the ETF industry. Hugging a market index involves less industry from the industry. There has been somewhat of a stall in market volumes over the last few years that perhaps this mix of passive and ETF explains. Some of this is due to a lack of trading intention even though such passivity represents, somewhat paradoxically, an increasing share of actual trading. See the FT article by Robin Wigglesworth from January 2017, “ETFs are eating the US stock market”:

Luminex May 2018 Recap
click to enlarge

Luminex May 2018 Recap
click to enlarge

Similarly, dark liquidity impedes price efficiency and the risk transfer process by disguising the liquidity picture. This is not so bad if you wish not to impact the price, but not impacting price is also a form of manipulation. You’re avoiding the impact your trade may otherwise should have. Price discovery is impeded by the horror of the growing darkness. Even the public exchanges are twisting into the downward spiralling vortex of darkness with IEX being the chief horror story abusing efficiency and price discovery.

The irony of an iceberg, or a lie about the true size of your order, should be reconsidered, just as pretending your order is big when small is considered an illegal spoof3.

If everyone bought and sold the index, no prices would change. If all liquidity was dark there would be nothing to set the prices for the parasitic darkness. Efficiency be damned. There is a certain amount of good from index funds, ETFs, and darkness. Yet, too much of a good thing may kill you.

Financial transaction tax will help normal investors

Be careful what you wish for. Liquidity is not magic but sometimes a hard-won feature. It took CME nearly thirty years to build their FX future liquidity. Market liquidity and efficiency are not always easy to come by. An FTT harms market efficiency, but it is a matter of size.

People often say there needs to be a financial transaction tax (FTT) to slow the market down and make it more purposeful. Adding friction obviously harms efficiency. It should be obvious an FTT doesn’t help as damaging efficiency is probably not a good idea. Size matters. If it is large enough it will destroy a market. Sweden is the poster child for such damage. It is also little understood there is already an FTT in the US. This is the small tax in place that essentially funds the SEC from public company transactions. It is wrong that private companies evade this tax. The government should level this playing field.

That said, FTTs with too much heat may evaporate much liquidity. Pause and consider carefully any FTT proposal. The consequences are probably not what you intend.

Measuring Efficiency

Measuring efficiency is tough. Spread is often a good proxy but it also falls down for specific aspects. Efficiency is also about the trades that are wanted that do not trade. Spread doesn’t capture that. Efficiency is about the reliability of the liquidity at best over time. Efficiency is about both absorbing large trades with little impact and recognising the impact of changing information that may cause the desire to trade.

A smarter fund manager will likely trade passively when they can and just cross the spread when they feel they have too. Some efficiency measures will see such trading away from the midpoint as bad. Under such a regime, this is reported as a bad outcome for the fund manager who has just benefited. IEX is particularly guilty of such misdemeanours, as is the tardy Dr Hu’s4 SEC report. Measuring correctly is sometimes hard. Look out for measurements that may deceive. Looking at you, Dr Hu.

The liquidity dance

To me, liquidity represents the ability to execute a trade. More liquidity means a bigger trade can be executed with less price impact. It is not easy to draw comparisons between markets by simply looking at the displayed liquidity though. Often much of the liquidity exists off-market, is hidden, or its reliability exists over time.

For example, there are some interesting commodity markets where there is always a few contracts on the bid and offer with a reasonably tight spread. That is, regardless of activity, there always is a small displayed market over time. Integrated over time, the market is quite liquid even though it is instantaneously quite illiquid. All is not what it seems.

The message this kind of market delivers is important. It is not just about what is displayed but it is also the behaviour of the market.

This is one reason why faster exchanges typically have better liquidity and serve the market good with greater efficiency.

Take for example IEX, with a 350-microsecond delay, or a 700-microsecond round trip added to the processing time. Contrast this with an exchange that may serve the public in 100 microseconds. Now, this fast speed doesn’t seem to help the average punter, but it does. A fast trader can accept your order, hedge, and be ready to do the same again several times before an IEX customer even would know about the trade. This doesn’t help the individual trades directly but it helps all individual trades collectively. The liquidity over time can be much greater with less risk at faster exchanges. IEX interferes with this process and harms the market. At IEX the lit liquidity at best is usually non-existent or small but this understates the poor quality of the market as the slow speed of IEX also means that the liquidity integrated over time is even worse than its peers due to its slow speed. IEX sux.

A faster speed for arbitrage, hedging, and information transmission greatly improves a market by enabling more liquidity. The market is better. It is not about the individual trade but it affects all individual trades as a collective.

Think of it as a dance. An investor takes the price on offer. The dance begins. A market maker (MM) is likely on the other end. They may be at their inventory bounds and may pull orders from other locales. They may instantly hedge via an arb at the exchange or at another locale. This arb may be in another product. The MM may even immediately repost anticipating a likely hedge. The dance between the MM and the investors is quite something if you think about it.

Both the MM and investor can win. Even more importantly, two medium or longer term speculators may also win. It is the nature of markets that they are not zero-sum games as many people may think. I’m yet to see a market completely disconnected from the real world, or at least, disconnected from other markets.

As part of this liquidity dance, the lead may be taken by an asset manager wishing to hedge part of her $100 billion portfolio. Say she hedges 10 per cent in the market by selling $10 billion in futures. Now other traders are holding $10 billion of delta risk. If the market goes up 20 per cent the asset manager is happy as she has gained $20 billion on her portfolio and lost only $2 billion on their hedge. $18 billion in gains would make me happy. The mass of speculators, in whatever markets the delta has diffused to, are also happy as they’ve gained that $2 billion. Markets have a purpose.

I refer to this aspect as happy losing. This is an underrated market aspect I wrote about in 2013, “Hedging – losses as profits that feed traders”.

You dance with the MM, they shuffle, twist, and continue to provide a suitable dance partner with the magic of connected financial services. It is quite a delightful and intricate dance if you think about the connectedness and impact on all of us over time.

Regulators have a responsibility to make it safe to dance. The government has a responsibility to enable all of us to dance if we want to.

There are some uncomfortable truths in the current market structure. Index funds and ETFs erode price efficiency as they grow. Likewise parasitic dark liquidity, especially at public exchanges like IEX, damage the utility of the public markets. More speed is good even if you hate it and over anthropomorphise faster than eye-blink speeds. There is no known answer to sudden bouts of market volatility. The growth of private markets is harming public markets, the public, and the SEC’s funding. Markets can still be irrational and subject to animal spirits.

Dance safely.

Happy trading,


And one more time, it is catchy 😃.

  1. The Safety Dance

    Men Without Hats


    Ah we can dance if we want to, we can leave your friends behind
    Cause your friends don’t dance and if they don’t dance
    Well they’re no friends of mine
    I say, we can go where we want to, a place where they will never find
    And we can act like we come from out of this world
    Leave the real one far behind,
    And we can dance

    We can dance if we want to, we can leave your friends behind
    Cause your friends don’t dance and if they don’t dance
    Well they’re no friends of mine
    I say, we can go where we want to a place where they will never find
    And we can act like we come from out of this world
    Leave the real one far behind
    And we can dance.

    Ah we can go when we want to the night is young and so am i
    And we can dress real neat from our hats to our feet
    And surprise ‘em with the victory cry
    I say we can act if want to if we don’t nobody will
    And you can act real rude and totally removed
    And i can act like an imbecile
    I say we can dance, we can dance everything out control
    We can dance, we can dance we’re doing it wall to wall
    We can dance, we can dance everybody look at your hands
    We can dance, we can dance everybody takin’ the chance
    Safety dance
    Oh well the safety dance
    Ah yes the safety dance


    We can dance if we want to, we’ve got all your life and mine
    As long as we abuse it, never gonna lose it
    Everything’ll work out right
    I say, we can dance if we want to we can leave your friends behind
    Cause your friends don’t dance and if they don’t dance
    Well they’re no friends of mine
    I say we can dance, we can dance everything out of control
    We can dance, we can dance we’re doing it wall to wall
    We can dance, we can dance everybody look at your hands
    We can dance, we can dance everybody’s takin’ the chance

    Oh well the safety dance
    Ah yes the safety dance
    Oh well the safety dance
    Oh well the safety dance
    Oh yes the safety dance
    Oh the safety dance yeah
    Oh it’s the safety dance

    It’s the safety dance
    Well it’s the safety dance
    Oh it’s the safety dance
    Oh it’s the safety dance
    Oh it’s the safety dance
    Oh it’s the safety dance

    Songwriters: Ivan Doroschuk
    The Safety Dance lyrics © Universal Music Publishing Group

  2. A prejudice that this author also shares.

  3. For further information, or prejudice, on spoofing here is a link to my previous article “To spoof, or not to spoof, that is the question”

  4. Dr Hu get’s it wrong as discussed in this meander IPCC wrong on climate change & SEC wrong on IEX

  5. This is the the Australian/British "gaol" which is jail in Amercian and often now jail in Australian too though the original "gaol" is still used. I guess I could have used prison but I liked the literary twist on the preceding use of "goal". Sorry for any confusion ;-)