Norway Wealth Fund Outsmarts Flash Boys as Algorithms Abandoned
bloomberg.com
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I suspect that an equity desk takes the block, parcels it out into lots of small pieces, and works the market to get it off their books. Of course, they charge for that service, both in commissions and spread. So effectively, instead of paying HFT firms for providing liquidity, they're paying an investment bank equity desk. Does this really save money? If it does, why all the hoopla about HFT if you can avoid them by going through an equity desk?
Don't tell me that they just put their block on IEX and the tooth fairy fills it without price impact. That would be some serious magic.
I think the "black and white" rule that the large firms who feel they are being hurt by HFT want is the ability to execute a full trade before it impacts the market (since otherwise it's impossible to describe the exact moment they feel their trade is a signal to be traded off of). I think that's highly unreasonable, but if you do believe that I think IEX is probably relatively successful at it. It's totally possible that a block could be fully sold off on IEX before the 350ms latency allows that information to escape to the outside world and be traded against, no? Market impact is ultimately about the same, just delayed enough to allow the seller to escape.
I would happily be correct on any of this, since I don't work in finance.
Let's say B instead only buys 250 shares, what happens to the remaining 250 shares?
IEX has this transit latency because they have order types that offer pegged execution, i.e. midpoints. A midpoint order is executed at the midpoint of the prevailing NBBO. The data required to build a view of the prevailing NBBO comes in from all other lit venues.
IEX has a 350us delay because they want to slow down the order entry side to give themselves enough time to make sure they are not pricing their pegged orders using stale market data. Simple as that.
These guys are ginormous. $100m block is about a 0.01% position for them. You can't just put a limit order on IEX (or any other exchange for that matter) when you're dealing with this magnitude. You need a team of specialists working full time disguising the order and parceling it out to multiple venues, and it will usually take days to get it done.
The other way of moving a block this size is by finding a natural counterparty and negotiating a deal directly with them. The trade will then get booked through a broker-dealer for reporting and settlement purposes. Those kinds of negotiations take days, too, and you can't avoid showing your hand. Plus, it's not a very scalable solution.
Sell siders are compensated because they will build into the price the expected impact. The pension fund gets a known price impact with essentially 0 variance and the sell sider takes on the risk of execution to offset the trade, and essentially earn a spread between what the pension fund paid them for the risk transfer and their 'skill' in getting the trade done in the market.
It obviously can and will be more complicated than that with varying benchmarks and compensation schemes, but that is the jist of it.
They aren't outsmarting anyone. They're simply transferring execution risk, and they pay handsomely for it, trust me.
But the firms that do play liquidity -- the firms that compete with one another for your order after it comes thru your broker -- aren't hurting anybody by front running. In fact, they value your order flow so much (for their own info) that they price-improve for you so they capture more/all of the order. IIRC over 60% of stock trades are price-improved.
The term "front-running" is terribly misused in these discussions (I can't tell from your short comment if you were, though). You "front-run" someone if they reveal their trading intent to you, and front-running usually involves an agency problem (ie, your broker and their responsibility to you as a client).
Historically, in the HFT world, it also involved getting ahead of big orders in the order book by taking advantage of how orders are systematically queued or prioritized.
I have no idea if this is still an issue (doubt it), but it was in the early days of HFT. Anyway, I'm out of my element...'Dark Pools' is a decent read if you're into this stuff.
About liquidity providing... brokers don't generally route orders directly to an exchange. In most cases your order will get routed to a 3rd party liquidity provider, a firm who agrees to buy at the bid and sell at the ask and do so quickly. Often, these guys will pay the broker for order flow or price-improve your order to capture all of it, or both. Competition between these firms goes a long way towards guaranteeing the NBBO price that your broker is obligated to provide.
Connecting the dots leads you to a conclusion that the order flow is valuable enough to them (for purposes of their own prop trading, strategic option selling, etc) that they act as market makers.
> In most cases your order will get routed to a 3rd party liquidity provider,
This is only true if you are a regular person, ie using IB to buy in your rrsp or ira account. Almost exclusively, anyone who is a professional will go direct to market( DMA). They will never go through Citadel or some other liquidity provider.
> Often, these guys will pay the broker for order flow
Not often, always. They always pay for this, there are no freebies:)
> a firm who agrees to buy at the bid and sell at the ask and do so quickly.
If you can find someone who will guarentee that they will fill my buy orders at the bid and sell orders at the ask, please let me know and I'll give them all my flow:)
> Competition between these firms goes a long way towards guaranteeing the NBBO price that your broker is obligated to provide.
What does this even mean, even without someone buying your flow you are still guaranteed to get the NBBO price, RegNMS says this is the law. Let me be clear, 3rd party brokers have no part in guaranteeing you get the NBBO price. The law says if your order can trade at the NBBO, it must.
1. Brokers don't only send orders to 3rd party market makers because they're being paid for order flow. You're right, they won't get order flow for free, but I didn't mean to imply that they did.
2. Quoting and buying at their published bid/ask is precisely their function. Possibly we're just disagreeing on terms. The SEC's website is fairly good at explaining this flow. http://www.sec.gov/investor/pubs/tradexec.htm
3. What I'm discussing is the actual mechanism for HOW nbbo is fulfilled. Competition in the marketplace -- third party market makers and arb firms -- absolutely play a role in ensuring the efficiency of the market. If brokers had to run this infrastructure themselves, it would be non-trivial and without any financial incentives that I can think of.
I think he was making a little joke about this. He said:
fill my buy orders at the bid
and sell orders at the ask
Of course, that wasn't what you originally said, which was
a firm who agrees to buy at the bid
and sell at the ask
[1] http://en.wikipedia.org/wiki/Knight_Capital_Group#2012_stock...
Right, but the inverse isn't true. Not all liquidity is speculative. And third party market makers are surely making money from providing liquidity but not by taking the other side of a trade.
https://news.ycombinator.com/item?id=8577237
It didn't really get any attention.
Interesting... given that large blocks are what HFTs feed on.
How exactly is a party suppose to drastically increase supply / demand for a stock without impacting price?
This is pure pedantry on my part, but I wouldn't want the thread to leave the impression that "block trades" are some technological feature of electronic markets. They're a fundamental problem of trading.
“Trying to find liquidity without having an impact when you’re doing it is an over-arching challenge we will always have,”
Huge players don't want to have a price impact before they trade - they want the price impact to happen after. I.e., it'll happen to the little guy rather than to them.
1. Broker takes client order.
2. broker trades his own account first (with knowledge of client order)
3. Broker executes client order.
If you don't have clients you can't be front running. It is black and white and as simple as that.
It's also Front running and illegal to pay a Broker for prior knowledge in front of their clients trades.
Also, the term may apply to using insider knowledge. Khan & Lu (2008: 1) define front running as "trading by some parties in advance of large trades by other parties, in anticipation of profiting from the price movement that follows the large trade". They find evidence consistent with front-running through short sales ahead of large stock sales by CEOs on the New York Stock Exchange. http://en.wikipedia.org/wiki/Front_running
" "Front running" is sometimes used informally for a broker's tactics related to trading on proprietary information before its clients have been given the information.
For example, analysts and brokers who buy shares in a company just before the brokerage firm is about to recommend the stock as a strong buy, are practising this type of "front running". Brokers have been convicted of securities laws violations in the United States for such behavior. "
This is not a problem when the principal has an exchange seat and may execute directly. Where firms are performing multiple-exchange arbitrage, and the principal splits a large order into several for execution across multiple exchanges, there is now an opportunity for something like front-running: the arbitrage firm can detect the principal's intent from the first order to hit the first exchange, and then try to move the market profitably (against the principal) on the other exchanges before the correlated orders can execute. While somewhat analagous, this activity should not be referred to as front-running.