Joseph Saluzzi (jsaluzzi-at-ThemisTrading.com) and Sal L. Arnuk (sarnuk-at-ThemisTrading.com) are co-heads of the equity trading desk at Themis Trading LLC (www.themistrading.com), an independent, no conflict agency brokerage firm specializing in trading listed and OTC equities for institutions. Prior to founding Themis, Sal and Joe worked for more than 10 years at Instinet Corporation, pioneers in the field of electronic trading, and at Morgan Stanley.
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Steve Chiotakis was a casualty of the financial crisis; he lost his job as a stock-broker in Frankfurt. Shed no tears for Steve, however, for he has entered into the Exchange Business: the Sausage Exchange Business, to be exact! He invested his $80,000 in savings, and has opened a lunch stand in the heart of the financial district where he used to work. He now served stressed out bankers, brokers, and exchange workers sausage lunches and fries named after the major indices, like the Dax, The Nikkei and the barbeque-flavored Dow Jones. His story is here: In Frankfurt, From Stocks to Sausages.
His story makes us smile, until we are reminded of all the parallels with stocks and sausage in our domestic US stock markets. Let me explain:
Once upon a time in America there was a marketplace where all types of order flow interacted. This was in the recent past (we are not taking you back to the 1988 specialist system, mind you; we are talking recent electronic trading history). What was neat about this place was the simplicity and intuitiveness of its inner workings. The electronic marketplaces typically utilized a price/time priority pecking order for simplicity and fairness. For example, if two orders to buy IBM for $50.00 were sent into an electronic book, they would be executed based on who was there first. If reserve books were utilized, then the visible portions would be eaten through in an intuitive manner. Orders were sent directly to these electronic exchanges, and they were meaty. Like steak! Spreads were relatively narrow (a few pennies), order execution times were measures in sub-seconds, and perhaps as long as a second or two. Average trade sizes were fairly robust (think a few thousand shares versus 116 shares). Liquidity flourished, and even so in crossing systems that complemented the visible electronic exchanges, such as ITG’s Posit, or Instinet’s Crossing Network (I wonder how Jim Ross is? He was a real nice guy). They were not called dark pools then, although those were the closest things to dark pools that any trader today will ever see.
Is your memory jotted? Good. Now let’s take a look at what we have nowadays.
There is no simply phrased order (i.e. Buy 50,000 IBM at $50.00, or Sell 6,400 COMS at $16.75) that gets sent to an electronic exchange. Meaty orders instead enter a Sausage Grinder that cuts them up, shreds them into tiny pieces, and delivers them to a nebulous cloud of 14 “exchanges” and dozens of “dark pools”. But they are not delivered directly to this cloud. No No! They are sent through “routes”. These routes are broker routes, as well as exchange routes, mind you. For institutional traders and retail traders, they work kind of like this:
– An institutional trader will typically use the algo of his/her choice, where it will be sent through an obstacle course of Select Liquidity Partners, Enhanced Liquidity Partners, Preferred Liquidity Partners, Dark Liquidity Partners, and even BFF Liquidity Partners, before they make their way to a protected exchange, to interact with other public orders seeking liquidity. The orders are all just dripping wet with liquidity we like to call the sweaty handshakes. The Liquidity Partners are of course all internalizers and DMM’s, and the hierarchy of Liquidity Partners where the institutional order is sent depends on who is rebating the algo provider the best, and/or charging the least for execution. Time/price priority means nothing in this cloud. And when the order finally gets to the public markets, or the 65% of it that hasn’t been nibbled, dark internalizers step ahead of the order by a thousandth of a penny, or co-located HFT firms beat the order to its intended price by a microsecond.
– A retail order is just flat out sold to the highest bidding internalizer, who will pay for that retail order because they will make money on the order. No cloud. Just instant conflict-of -interest. Just instant sausage.
By the way Direct Edge updated some route for the month of May yesterday.
From the Direct Edge website: Inside the May 2011 Release.
– EDGA will get a new routing strategy, called “ROBB” (no we did not name it; they did!) which automatically receives your algorithms order, and sends it through EDGA, BX, and BYX.
– EDGA will also get “ROCO”, which takes your delivered algo order and routed it though EDGA + BX + BYX + CLC + MPM. Simple right?
– Direct Edge also improves “ROUC” so that your order routes through the DirectEdge book + CLC + MPM + other low priced destinations.
– To standardize the behavior for non-IOC orders, ROUD, ROUZ, ROBA, ROBX, ROBY, ROPA, IOCX and IOCT will be updated so that any remaining shares returned from the Router will interact with liquidity on the book and then post to the book, subject to re-pricing. All other non-directed strategies already behave this way.
Simple? Want to look at NASDAQ’s routes? The routes from BATS? How about those from good old NYSE/Arca?
Every route is a point of contact between an order and the market place, which is teeming with 60-70% HFT’s that are owned by brokers, who own exchanges, who own dark pools and other exchanges, which are owned by different brokers. Simple? Why are you incurring slippage? Why are you leaking? It’s the “liquidity”, silly!
Sausage. It’s what’s for dinner!
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