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SOES Bandits Revisited

23

July, 2010

Today we are going to do a little electronic trading history lesson.  Who remembers Sheldon Maschler?  Harvey Houtkin?  They were the original SOES Bandits.  Sheldon headed up the infamous Datek Securities.  In 1989, with the help of two boy wonders, Jeff Citron and Josh Levine, they created Watcher, a software program that allowed day traders to take advantage of a weakness in the SOES system–relatively slow updating of price quotes (sound familiar to anyone?).  SOES was intended for small orders but Datek was using the system for large trades, buying stocks and then selling them again within seconds.  Datek was very successful at scalping trades and by 1996, they had 500 traders, many of them freshly out of Ivy League schools but already making as much as $750,000 a year (hmmm, take the brightest minds out of the best schools and have them perform a function with no economic value so they can earn obscene salaries…again, sound familiar to anyone?).  In 1997, Citron and Levine developed the Island ECN and with the strategy of paying rebates for posting of liquidity, Island grabbed 15% of NASDAQ trades by 1998.  They tried to take Datek public but a series of criminal and regulatory investigations prevented them from doing so.  Island was later bought by Nasdaq.  The data feed that Nasdaq now uses, ITCH, was originally created at Island. 

 Harvey Houtkin was another famous SOES Bandit.  In 1998, his firm All-Tech also created an ECN called Attain.  In 2005, Attain was sold to Knight Trading.  Knight renamed it Direct Edge.  Knight then sold stakes in Direct Edge to Goldman Sachs, Citadel Investments and the ISE.

 So where are we going with this?  On Wednesday, Direct Edge officially became the fourth stock exchange in the US.  It is truly amazing that an ECN that still employs pre-routed or “flash” orders was granted exchange status. They can now compete directly with the other big boys, NYSE, NASDAQ and BATS.  They have set their sights on the lucrative proprietary market data space.  These data feeds are the lifeblood of the HFT industry.  Think of them as the fuel that runs the Lamborghini.  They said they will begin selling this data to industry participants, most likely HFT firms, over the next few months.  They also have amped up their speed to 300-400 microseconds which should make the HFT traders very happy.  And one final thing, they have also announced their intentions of a future IPO of the company.

 The similarities between SOES and HFT are striking and history is truly repeating itself now.

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