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The Importance of Order Type & Special Feature Transparency

The Importance of Order Type & Special Feature Transparency

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Published by calibrateconfidence
The Importance of Order Type & Special Feature Transparency
The Importance of Order Type & Special Feature Transparency

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Published by: calibrateconfidence on Jan 29, 2013
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Haim Bodek is a market structure pundit and an HFT (high-frequency trading)whistleblower. He’s been getting lots of recent attention for his somewhat controversialaccusations that stock exchanges have worked with HFT firms to give them an unfair edgeover everyday investors. He has written and spoken about the financial industry and is anexpert on the positives and negatives of the HFT game since he’s been on both sides of it.Bodek revealed his findings to the SEC and a subsequent September, 2012 article in theWall Street Journal put him in the spotlight.In the below Q&A, Bodek speaks about orders that “hide and light” or “hide and slide,”and how special features used by HFT firms, he believes, are providing an unregulatedadvantage.
“I felt that the stock market had basically become so distorted that it was negatively impacting other algorithmic tradingtraditions and really destroying the diversity that should exist inthe market.” 
What was it was like to work with Scott Patterson on his book, DarkPools?What was the catalyst was to tell your story through that outlet?
He caught me at a sensitive, delicate time. I was angry about a number of deep marketstructure features. There was a particular algorithmic trading tradition that I bumped my headup against. I felt I needed to correct it or defeat it in some way. I was introduced to him by oneof his other sources, who felt that I could illuminate some of the aspects of the HFT industrythat were not generally talked about in the greater newsand the community.I worked with Scott to educate him about scalping practices and howspecial order types workand how exchange order matching engine features benefit HFT. I showed himhow opaqueand non-transparentmany of those features were, and how, in many ways, the industryhadtaken advantage of the buy side and institutions to benefit certain types of firms runningspecific strategies.
How might orders that “Hide and Light” provide an advantage forhigh-speed traders?
Orders that hide and light are a clever work around the ban on lockedmarkets, which is aregulationNMS rule; a constraint that prohibited firms from locking the market.There are hidenot slide orders, postno preference blind, price to comply, BATS only…these orders permitcertain firms that are usuallyquite sophisticated, to lock a market for a brief amount of time(that’s when these orders are in ahidden state), and then when the market moves, theseorders can light up.Now, in themselves, if they’re designed correctly, and documented correctly, and used by themajority of participants in the right way, they might not be so bad.The problem is there arequiteanumber of perks that were thrown in that serve to advantage certain types of traders,thrown in asperks with these orders – and these features are actually one of the main reasonsI became a market structure reform advocate.
The Importance of Order Type &Special Feature Transparency
Haim Bodek
HFT Whistleblower
1 (888) 482.6012
One of those features was reported in the Wall Street Journal. It’s called “queue jumping,”and allows a hide not slide order to get ahead of other orders in a way that, I would argue,is a violation of price-time priority order precedence rules at the exchanges.
At your previous firm, Trading Machines, you leveraged high-speedtrading technologies, and for a brief period, orders that hide andlight. You spoke about how you started to become a bit more of anadvocate for transparency, but why did you, as a high frequencytrader, want to engage the SEC to bring transparency to the issuesaround these special orders? What was your goal there?
I came to the conclusion that if you weren’t playing the HFT game, while you could improveyour execution performance quite considerably by using some of the techniques and ordertypes, really the entire ecosystem itself had been distorted. There was really a situation whereyou either had to join them and become a stock trader – a high frequency trader just focusedon the stock market. I was more on the option side of business.I felt that the stock market had basically become so distorted that it was negativelyimpacting other algorithmic trading traditions and really destroying the diversity that shouldexist in the market.
My next question is about exchange officials who have said thattheir order types and work is fully disclosed. Would you agree withthat statement?
A good example would be queue jumping which is a feature that is often marketed directly tofirms, to high frequency traders primarily, which is not in any way supported by exchangedocumentation. There are a number of other perks, many of which are not disclosed yet ordocumented in any capacity. I came to the conclusion that a smart person could figure thingsout if they had access to the documentation. A lot of features people think are documented…but if you actually go and look for the documentation, you’ll find they aren’t. So how dopeople learn about it? They learn about it from other people in the industry. It’s a little bit ofa closed club that really has to be broken for the markets to move on.
What advice would you have for the buy side traders who areoperating in markets where high-speed traders might have an edge?What can they do? What would you tell them?
The first step is to realize that the features and the order types used by HFT – theseexchanges have become so dominated by HFT-oriented activity that if you aren’t using thosefeatures and those order types in the correct way, you’re really on the wrong side of theslippage of equation. It’s not about picking up the rebate. It’s about getting really fair andneutral access to the exchange and if you’re not using an HFT-oriented exchange correctly,you’re probably falling into many of the abuses that I experienced prior to learning abouthow these features work.You have to learn how to use the exchange correctly. Until regulators step in and change themicrostructure, it’s really an obligation on the sell side brokers and the buy side to operate andaccess the markets more like an HFT would. I’m not really trying to advocate for HFT. I’m reallyadvocating for transparency and documentation on these features and then a generalknowledge across industry that these features matter. Getting to the top of the queue matters.If you don’t use the mechanisms to compete correctly, you’re going to be at the back of thequeue and that’s disadvantaging you or your client.
“In themselves, if they’redesigned and documented correctly, and used by themajority of participantsin the right way, they might not be so bad. The problem is there are quitea number of perks that were thrown in that serveto advantage certain typesof traders, thrown in as perks with these orders.These features are actually one of the main reasons I became a market structurereform advocate.” 
1 (888) 482.6012

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