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Monster Under The Market

15

November, 2011

 

No, we aren’t trying to scare you! And while we often talk about our crooked and warped market micro-structure being a monster, this morning we would just like to go back in time with a little modern stock market history lesson, and talk about another monster: the Monster Key.

What the heck is a Monster Key, you ask? We want to explain, but first need to remind you of another past history lesson from our morning notes in July 2010. In that morning note we talked about the original SOES Bandit: Datek Securities, and its founder Sheldon Maschler. In that note we alluded to the software that boy-wonder Josh Levine created to pick off NASDAQ market makers: Watcher. Watcher alerted day traders in Datek’s shop to instances where market makers were slow to update their quotes, so that the day traders could pounce on the opportunity and exploit the Small Order Execution System (which was supposed to be used for retail orders, and not prop trading) by using it to send in auto-execute orders against slow market maker quotes.

Here is where we get to the Monster Key. You see, Datek traders stumbled across the inner workings of how NASAQ worked, namely price-time priority of orders. If stock was for sale by a market maker at $20, and 50 traders were all trying to SOES that offer simultaneously, only the fastest of them would get the rewards of the $20 stock. However, if they entered SOES orders at a higher price than the $20 offers, their orders jumped to the front of the queue! Price trumped speed AND they got the $20 offer just the same. Jackpot! And so Levine automated the “pricing through the market” of all of the Datek firm’s orders, and called it the Monster Key.

And why do we ponder the Monster Key? Because it reminds us very much of the ISO-sweep order, an order type used by HFT firms (and not retail). Today jumping in front of the queue is just as important as it was to Shelly at Datek. Actually it is about a billion times more important.

This morning we just want to again remind everyone of the parallels between HFT and the SOES bandits. Back then, however, the stock market was non-for-profit, and was bent on trying to contain the “banditry”. Today, the stock exchanges arm them instead.

Bugs Rocks by the way.

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