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The Great HFT Debate

19 November 2012

Why HFTs Have an Advantage, Part 4: Winner Take All -- The DAY ISO

Perhaps the most powerful order type in the HFT arsenal, the DAY ISO is the only order type that can light a new aggressive price on an exchange that locks an away market, providing an end-around to Rule 610 and the ban on locked markets and providing HFTs a backdoor to the top of the queue.

 Rule 611 of Regulation NMS, also known as the Order Protection Rule, introduced Intermarket Sweep Orders (ISOs) -- e.g., the Immediate or Cancel (IOC) ISO -- that provide institutions a means to comply with trade-through rules while executing large orders that need to sweep through multiple levels of the order book across multiple market centers. However, as previously discussed, high-speed traders leverage ISOs for another reason : to get an edge over less sophisticated traders in fast moving markets, particularly those traders who rely on exchange mechanisms for compliance with Rule 611, mechanisms that expose orders to the adverse effects of slow Stock Information Provider (SIP)data  feeds.

(See: “Why HFTs Have an Advantage, Part 3: Intermarket Sweep Orders”)

In addition to defining IOC ISOs, Rule 611 also introduced another ISO variant -- the seemingly non-controversial DAY ISO order type. In fact, the DAY ISO is anything but innocuous; rather, it is an essential HFT-oriented order type packed with advantages.

As with the case of IOC ISOs, high-speed traders employing DAY ISOs can gain access to prices that would normally be inaccessible to traders who rely on exchanges to comply with trade-through rules., The DAY ISO, however, combines all the advantages of IOC ISOs with powerful features that HFTs exploit to book orders at the top of the queue, capabilities that in fact trump the capabilities of most other HFT-oriented order types.

Originally, the DAY ISO was intended for institutions that wanted to sweep to a particular price level and then post at the best price – for example, clear the offer, then bid aggressively for more at the old offer price (buy all you can at the offer, then post a limit to buy the remainder at the old offer price). To use a DAY ISO, a broker-dealer is required either (a) to show it isn’t locking or crossing away markets, or (b) to sweep markets displaying prices it would otherwise lock or cross. Thus the DAY ISO order addresses conditions in which Regulation NMS puts constraints upon an order to simultaneously satisfy the ban on locked markets stipulated by Rule 610 and the trade-through rule stipulated by Rule 611.

However, the DAY ISO also provides a way to step ahead of orders that are already resting on the book  -- orders that were originally submitted at the same price but were price-slid or hidden to comply with Rule 610 and the ban on locked markets. This advantage -- the remarkable ability to step ahead of orders resting on the book at the same price -- gives DAY ISOs a unique edge over the bulk of order types, including orders that “hide and light.”

(See: "Why HFTs Have an Advantage: Part 2: Hide & Light”)

Like orders that “hide and light,” the DAY ISO can be used by HFTs to lock away markets that are in fact stale phantom prices on the SIP feed that are no longer present on the away exchange. Unlike “hide and light” orders, though, the DAY ISO enters the market as a protected quotation and is eligible for immediate display on the book, whereas the “hide and light” order must remain in a hidden state until the away market unlocks. When sending a DAY ISO in such conditions, the burden of liability is on the HFT to demonstrate that the direct feeds used indeed show that away markets have truly faded and that there isn’t a pattern of locking protected quotations on away markets or any violation of Rule 610. If, for any reason, an HFT desires to lock an away market that displays a firm quotation (and not a phantom quotation) with a DAY ISO, the HFT would also have to take out the away market with an ISO. The other option in such a scenario would be to simply use a “hide and light” order.

DAY ISOs, like “hide and light” orders, avoid conditions that would normally result in rejection, rerouting, or disadvantaged price-sliding of aggressive orders -- unfavorable order treatment that typically occurs when an exchange employs a slow SIP feed to assert compliance with the ban on locked markets and the trade-through rule. Not only do HFTs exploit DAY ISOs to get ahead of slow SIP feeds while avoiding the disadvantaged exchange order handling treatment described above, HFTs also use DAY ISOs to step ahead of “hide and light” orders already resting on the book. What is most remarkable about DAY ISOs is this ability to queue jump orders that arrived at the exchange at the same price as, but prior in time to, the DAY ISO.

(For another example of price-time priority corruption, where orders that “hide and light” are permitted to queue jump orders commonly used by institutional investors, see “For Superfast Stock Traders, a Way to Jump Ahead in Line.”)

To appreciate the significance of DAY ISO queue jumping, it is key to understand that among all the special order types, only the DAY ISO can light a new aggressive price on an exchange that locks an away market. In practice, this lighting capability provides an alternative end-around to Rule 610 and the ban on locked markets and provides HFTs a backdoor to the top of the queue.

Lighting an aggressive price with DAY ISOs is a winner-take-all sport. The first DAY ISO that arrives to set a new NBBO will light the new price when it is booked. The new price will be displayed whether or not the order is locking an away market. HFTs often leverage DAY ISOs to get to the top of the queue on an NBBO change in cases where there is a slow SIP or when there are race conditions between prices disseminated on direct feeds. Hence, the fastest firm gets the top-of-queue and controls the actual “lighting of the market.” Indeed, HFTs are dictating the timing of an NBBO change on the SIP when using DAY ISOs.

After the DAY ISO is lit, all such “hide and light” orders that were resting on the book are then displayed, triggered by the ISO lighting event. It needs to be clarified that DAY ISOs, due to their status as protected quotations, are ranked ahead of all “hide and light” orders that exist in the subordinate hidden state at the same price. Thus DAY ISOs have the special ability to step ahead (i.e., queue jump) orders that previously arrived at the exchange and were resting on the book in a hidden state.

What about the case when two DAY ISOs are sent by competing HFTs? In this case, the second ISO coming into an exchange would fall behind all such lit orders, including “hide and light” orders that were queue jumped, even if the second DAY ISO arrived only microseconds later. Hence, when there is HFT competition to light a new price with a DAY ISO, second place really is the end of the line (the back of the queue). Especially in highly competitive and actively traded names, the HFT might as well cancel any DAY ISOs that fail to light the market rather than be posted at the back of the queue.

In summary, DAY ISOs were originally intended for large institutions that needed to sweep the book and post unfilled quantity at their most aggressive price. However, such orders became the mainstay of HFTs, which use them to post liquidity ahead of slow SIP feeds in order to light aggressive new prices. DAY ISOs assist HFTs in gaining a favorable queue position by queue jumping ahead of orders that “hide and light” as well as order types commonly used by institutional investors. Execution service providers that route aggressive orders to HFT-oriented exchanges yet fail to effectively utilize the primary features provided by such exchanges in the correct usage cases, including the appropriate usage of DAY ISOs and “hide and light” orders, are unnecessarily subsidizing HFT scalping strategies and disadvantaging their customers.

In the final article in his series on Locked Markets, Priority and Why HFTs Have an Advantage, Haim Bodek will discuss the further evolution of ISO orders in the context of the maker-taker model, including the Post-Only ISO and related order types.

Spotlight-white-trans For more stories in the The Great HFT Debate Spotlight Series click here.

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15 Comments to "Why HFTs Have an Advantage, Part 4: Winner Take All -- The DAY ISO":
  • Comment_230146_210851315613283_100000652474653_678322_2285980_n
    crammond1964

    20 November 2012

    this has been very obvious in STIR  contracts ; yet has been denied by exchanges . Probably the reason why  RSJ  and other HFT  have managed to increase their mkt share .

     The exchanges lack of honesty in their mkt proves they are not fit to regulate their own exchanges .

  • Comment_me2
    adslarge

    20 November 2012

    " To appreciate the significance of DAY ISO queue jumping, it is key to understand that among all the special order types, only the DAY ISO can light a new aggressive price on an exchange that locks an away market. In practice, this lighting capability provides an alternative end-around to Rule 610 and the ban on locked markets and provides HFTs a backdoor to the top of the queue. "           

    Is this not today's equivalent to Front running ?

  • Missing
    bmk2323

    20 November 2012

    On the flip side - suppose i'm a seller & the HFT is in the 'favorable queue position' on the bid side - i can hit them for their size, right?   

    In summary, DAY ISOs were originally intended for large institutions that needed to sweep the book and post unfilled quantity at their most aggressive price. However, such orders became the mainstay of HFTs, which use them to post liquidity ahead of slow SIP feeds in order to light aggressive new prices. DAY ISOs assist HFTs in gaining a favorable queue position by queue jumping ahead of orders that “hide and light” as well as order types commonly used by institutional investors. 

  • Comment_l
    lkovach

    20 November 2012

    WSJ: Exchanges Get Closer Inspection -- "The intensified scrutiny was sparked partly by an SEC probe into trading order types, which allow traders to control how their buy and sell orders are treated. Order types can control how much an investor will pay for a stock, whether the order can be routed to another exchange and whether the order will move up or down in price, among other things.

    "A number of order types benefit high-speed traders, whose activity comprises more than half of all stock-trading volume."

  • Comment_230146_210851315613283_100000652474653_678322_2285980_n
    crammond1964

    20 November 2012

    The sad fact that HFT  appears unaware of current rules and market supervision depts are currently just realized that the round wheel is faster than a square one .

     Maybe when volumes has totally withered to below "open outcry " levels we may accept that DAY ISO  are totally unacceptable illegal and cataylst to current problems  . On a serious point who allowed these to be allowed ?  This is part of reason why I now use "dark pools "  .

  • Missing
    Capitalist

    20 November 2012

    Crammond - you seem to repeatedly misunderstanding/misconstruing Haim's points. The questionable order types that he highlights apparently only exist in the US, where there are multiple competing exchanges linked via Reg NMS (and the trade-through rule).

    Your insistence that the same features/problems apply to European STIR derivative markets (where each product is "owned" by a monopoly exchange-CCP vertical silo) is non-sensical. Sure, you suspect there are other reasons why HFT firms can trade European derivative markets more successfully/profitably than you can - but it's not credible to suggest that hidden/ISO order types are responsible when they simply don't exist.

  • Comment_me2
    adslarge

    20 November 2012

    bmk2323..................  In my experience ( on many many occasions ) when I try and hit them for size ....  the bid /offer miraculously  disappears ...... it's like they knew my order was coming !!!!!!!!!!!!!!!!!!!!!!!!!

  • Comment_tabb_-_larry_tabb_hi-res_wo
    ltabb

    21 November 2012

    adslarge - look at the WSJ article talking about PL Select -

    http://online.wsj.com/article/SB10001424052970203400604578074963881803302.html

    this order-type as according to the WSJ -

    "PL Select is an order type that would allow fast-moving traders to avoid orders from firms such as other high-frequency traders or institutions seeking to buy or sell large chunks of stock.

    A PL Select order won't trade with orders favored by many high-frequency firms that cancel instantly if the order isn't executed. It also won't trade with any larger orders, giving high-speed traders using it the ability to post orders that will interact only with tiny orders typically sent by small investors."

     

    this may be what you are seeing

  • Comment_haim_linkedin
    hbodek

    21 November 2012

    The problem of disappearing liquidity is usually driven by the market impact of a multi-market sweep. HFTs typically cancel when the first toxic print hits the tape (e.g. best bid or offer fully traded out) . I like the approach RBC took to minimize the time window HFT has to pull liquidity in a multi-market sweep. See their product Thor: https://www.rbccm.com/thor/cid-260178.html

  • Comment_10x29_mackie_headshot
    cmackie

    21 November 2012

    Let me see if I  understand this: Day ISOs were created so that traders could aggressively bid or offer without locking markets and now traders that we choose to label as HFTs are using that order type to do just that.  That sounds reasonable to me.  What change would you impose on this: get rid of the Day ISO or the traders that use them?

  • Comment_haim_linkedin
    hbodek

    21 November 2012

    Cmackie. I am suggesting neither. I am suggesting that institutions need to utilize the features of HFT-oriented exchanges correctly and should execute like HFTs.

    That being said there a lot of tweaks you could make to level the playing field between DAY ISOs and other order types. You could eliminate the unnecessary queue jumping feature for example...

  • Missing
    BobsUrUncle

    23 November 2012

    ISO orders are restricted to firms that meet Reg NMS compliance requirements (i.e. audit trail). It's up to the regulatory agencies to verify that the firms are complying. If they can't because they don't have a reference audit trail, the problem is with the agencies then isn't it?

  • Comment_230146_210851315613283_100000652474653_678322_2285980_n
    crammond1964

    26 November 2012

    My argument has always been with the exchanges and their RIE  status . Sadly their regulation and market supervision is no way near up to standard and by ignoring abuse they have lost volume ; respect and confidence . Try and complain to an exchange and see my point ! 

  • Comment_10x29_mackie_headshot
    cmackie

    26 November 2012

    Haim - thank you for the clarification.

  • Comment_salarnuk
    sarnuk

    26 November 2012

    I wonder if Greg Berman at the SEC, and the whole Trading and Markets staff, understand how order types that were allowed/created via REG NMS to do one thing are being used for exact opposite purpose?

    Haim Is it fair to assume that DAY ISO can also be combined via modifiers with other "order types"? I wonder if, for example, an Arca PL Select order can be combined with - say - an ARCA Day ISO (Does ARCA even have a DAY ISO?)?

    Imagine if an order type could be created by any exchange, which discriminates against contraside (i.e. do not trade with incoming ISO's from institutions) like PL SELECT with a post-only type of ISO. It would avoid adverse selection, and at the same time queue-jump.

    I wonder if these things exist? I am scared if/that they do. Of course brokers can adjust and use these order types as well as HFTs in their institutional algos... but the whole game is a distortion of true markets and supply and demand.

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