You likely have heard his name over the past month. Haim is a “whistleblower” industry player who for years has worked developing quantitative trading strategies at Hull Trading, UBS, and more recently at his own firm operating out of Stamford Connecticut – Trading Machines. He is most notable to the industry however, for his illuminating how stock exchanges have been providing ultra-HFT firms (the commonly accepted term today being “market makers”) with unfair advantages that propel them to the exchanges’ best prices at your expense. He has been featured in Scott Patterson’s book, Dark Pools.
Tabb Forum, which we are not affiliated with, has a series of jaw-dropping articles written by Haim Bodek that you must read. These articles detail how HFTs game getting to the top of the limit order books in stock at your expense. He is hinting that there will be more articles to come as well – a series if you will. This is his first article, and this is his second one. Sign up for the forum if you have not already done so.
We wrote about Haim as well, in a note to you back in early August. And while some other “HFT-insiders” have been promoting themselves rather well in Washington DC, as well as on Wall Street, Haim is downloading what he knows to the public. He is allowing himself to be debriefed, for institutional investor benefit.
In his second article on TABB, Haim discusses “Hide and Light” order types and the strategies surrounding them. The article is enlightening. We are including the following few paragraphs for you:
A real turning point in the development of HFT-friendly order types was the introduction of orders that would “hide and light.” Where a regular order would be price-slid back a tick and lit at the slid price, these new orders would be priced to lock an away market. They would be hidden at the locking price and automatically light up once the away market was no longer locked.
The hidden price was permitted to lock an away market because it was not a displayed price and thus not considered a Protected Quotation under Regulation NMS. The hidden price was not covered by the provisions of Rule 610 that prohibited “a pattern or practice of displaying quotations that lock or cross the protected quotations of other trading centers.”
In other words, HFTs could get around Rule 610 and the ban on locked markets by mastering this powerful exception that permitted the HFT to “step in the middle” and lock an away market. However, this exploitation of a clever end-around of Rule 610 presented a new problem: how to simultaneously maintain queue rank and get converted from a hidden order to a displayed order. Because hidden order types are ranked below displayed quantity according to binding exchange order precedence rules, the utility of such orders was fleeting unless a mechanism could be provided to reserve one’s place at the top of the queue when the market displayed.
“Hide and light” order types solved this problem of reserving a superior queue position by, in the industry jargon, “lighting” the hidden order automatically when the order would no longer result in a violation of Rule 610 (i.e., when the away market “unlocked”). In other words, the primary advantage embedded in a “hide and light” order was its ability to transform from a hidden order into a Protected Quotation at precisely the time a market was permitted to display an aggressive price. It should come as no surprise that the power of the order type was almost purely in its ability to get an HFT to the top of the queue.
Hence, the “lighting” process became key to dictating an HFT’s queue position. In essence, “lighting” is the key event in which an exchange picks the winners and losers in achieving a superior queue position.
Most institutions are not even aware of the dependence of HFT strategies on exchange “lighting” events. For several years, and including to this day, the mechanisms through which orders that “hide and light” are converted from hidden orders to be rebooked as Protected Quotations are improperly and inadequately documented.
The comment section after Haim’s article is especially enlightening. Aside from the poorly-crafted sentences in my contributions (many of you have come to expect nothing less from me), there is valuable information for you, such as:
2) BATS Display Price Sliding – their Aug 14th, 2012 SEC filing on a significant overhaul and how they treated it. Hint: it was changed; it used to operate differently for years.
3) BATS bug fix from October 4th, 2012, where before the fix price slid orders were not un-slid. In error. Recall our October 9th, 2012 note to you on this topic.
4) Manoj Narang in 2010 describes how inferior queue costs you 1.7 cents per share. That cost wipes out any savings in spread reduction from the past decade!
5) NASDAQ had striking differences between their various protocols. They started normalizing late last year, though key differences remain. Here is a table comparing order type availability per protocol.
In essence Haim is discussing that there were/are order types that were furnished to ultra-HFT players that gave them advantages getting to the top of limit order books at your expense. Haim has apparently gone to the SEC with this information some time in 2011, based on media reports. So, the SEC knows about this. Some exchanges have been quietly cleaning up their unfair loopholes over the past year, and some exchanges have been less diligent in doing so. We can only presume that this is because the SEC has begun investigating order types, based on what they learned from Haim.
So institutional investors, no matter what transpires from this point on, owe a little gratitude to Haim for his efforts. Institutional investors also owe a certain amount of outrage to the US Stock Exchanges, with the help of regulators who have rubber stamped these order types, for selling them out for profit.
Stock exchanges and HFTs have created a rabbit-hole murky world that has savaged investor confidence, and cost them real money. This is not the first time exchanges have implemented policies and business decisions that they knew were bad for investors (flash orders and data feed leakage). Let us leave you with this statement of Haim’s which he made in the comment section:
To say institutional investors could simply use the order types is self-serving, as one needs to know exactly what to order type to send and when to send it. That is why the question of exchange disclosure and documentation is so key – if you don’t have the operating manual, you don’t have a chance.