BATS Global Markets Inc., under pressure from the New York Attorney General’s office, corrected statements made by a senior executive during a televised interview this week about how its exchanges work.
BATS President William O’Brien, during a CNBC interview Tuesday, said BATS’s Direct Edge exchanges use high-speed data feeds to price stock trades. Thursday, the exchange operator said two of its exchanges, EDGA and EGX, use a slower feed, known as the Securities Information Processor, to price trades.
The distinction matters because high-speed traders can use powerful computers and superfast links between markets to outpace traders and trading venues that rely on slower market data, such as the SIP.
That's a particularly uncharitable way to put it. Another way to put it is this:
Regulations encouraged a fragmentation in exchanges (a good thing, since they used to be monopolies).
For multiple exchanges to trade in the same instrument, some force needs to synchronize the prices between the markets.
The regulations specify a mechanism by which this might work: quotation feeds for different products replicate the NBBO ("current" best bid-ask) across the markets.
But the NBBO feed is only an approximation of the best feed --- and it has to be, as anyone who has ever built a distributed system must know.
Fast electronic trading can synthesize a BETTER NBBO. If you know what the better NBBO is, you can trade against it, in effect forcing prices to synchronize through arbitrage trades.
The net effect is that the markets synchronize on a more accurate BBO, and electronic trading systems get compensated for doing this based on the profits from the arbitrage trades.
In the ABSENCE of that trading, the delta between the SIP NBBO and the "real" NBBO still exists; it's just money in the pockets of a different set of entities.
In neither case was this money likely to be helping firms that hold long-term positions and make money by allocating capital; the previous crappy NBBO profits were just going to a different set of sell-side firms, who are now angry that they'd been obsoleted.
To me, an extremely telling fact here is that Vanguard's Chief Investment Officer went on the record and said that HFT trading, and latency arbitrage in particular, had been helpful to their trading costs. If that doesn't mean anything to you, do some research into how Vanguard works and is structured.
I'd be curious how much volume occurs like this. I'm in the industry and know of these issues but have never heard of a trade specifically designed to exploit it.
Exchanges aren't allowed to accept quotes that would lock/cross each other, so you'd need something to happen like two guys put crossed orders into a wide book like AAPL almost simultaneously on different markets. They'd have to be crossed by more than a cent since the trader taking them out would have to pay remove fees on both (~$0.006) and the person doing it would have the risk of getting legged if he gets the first order but another takes the second one.
They should fix the SIP but this is not a common HFT technique as far as I know.
BATS Global Markets Inc., under pressure from the New York Attorney General’s office, corrected statements made by a senior executive during a televised interview this week about how its exchanges work.
BATS President William O’Brien, during a CNBC interview Tuesday, said BATS’s Direct Edge exchanges use high-speed data feeds to price stock trades. Thursday, the exchange operator said two of its exchanges, EDGA and EGX, use a slower feed, known as the Securities Information Processor, to price trades.
The distinction matters because high-speed traders can use powerful computers and superfast links between markets to outpace traders and trading venues that rely on slower market data, such as the SIP.