Odd Lots -Another Weapon In The HFT Arsenal

The odd-lot trade. It used to be something that Aunt Ethel executed through her full service broker in Florida. Well, times have changed and odd-lots have now become a very frequent strategy of the high frequency trader. At Themis Trading, we see these odd lots occurring all day. That is to say, we know when our trades have odd-lots but we don’t know when other odd lot trades are occurring. The reason is because the consolidated tape does not publish odd lot data.

We know what you are thinking – big deal it’s only a few odd lots and they don’t add up to much. Well, according to a new research paper, odd lots matter and they are being used strategically by high frequency traders. The paper titled “What’s Not There: The Odd-Lot Bias in TAQ Data” Read Paper Here was written by Professor Maureen O’Hara from Cornell University. Professor O’Hara certainly knows alot about market structure. She is Chairman of the Board of Directors for ITG and she also is a member of the Joint SEC-CFTC Advisory Committee which has studied the flash crash ( Prof. O’Hara bio )

The paper states:

“In this research we investigated the odd-lot bias in TAQ data. We have demonstrated that missing trades are a large and pervasive problem in TAQ data. That trade sizes are truncated below 100 shares means there is a censored sample problem for all stocks. For some stocks, however, this problem is acute, with as much as 40% or more of trades missing from the data. Moreover, these missing trades are highly informative, meaning that analyses of issues related to market efficiency are also subject to error…Our analysis shows that odd-lot trades are now far from unusual, and market practices such as algorithmic trading and high frequency trading are only increasing their incidence.”

“We believe our results also have important policy and regulatory implications. TAQ data is biased because the consolidated tape is biased: odd-lot trades are not recorded to either data source. When odd-lots were a trivial fraction of market activity, this omission was of little consequence. But new market practices mean that these missing trades are both numerous and informationally important. Moreover, while these trades are invisible on the consolidated tape, they are not invisible to all market participants. Market venues now sell proprietary data that allow purchasers to see all market activity. Our results suggest that odd-lot trades now play a new, and far from irrelevant, role in the market. The SEC should recognize this new role and change the reporting rules regarding odd-lot trades.”

Because odd-lot trades are more likely to arise from high frequency traders, we argue their exclusion from TAQ and the consolidated tape raises important regulatory issues.”

Odd-lots are being used more frequently now for a few reasons. Pinging dark pools is one reason but Prof O’Hara also says that, “A round-lot trade can be split into smaller trade sizes to escape reporting requirements. Splitting the order into a 99-share trade and a 1-share trade is consistent with this practice.” Sounds a little like “tape shredding”.

Some of you may thinking now that this is still not a big deal since nobody can see these odd lots except the trader who executes them and therefore we are all still seeing roughly the same consolidated tape. But here is where the conflicted interests of the stock exchanges again comes into play. As Prof. O’Hara states in the paper, if you subscribe to a direct data feed from the exchanges, then you will see every trade that occurs, even odd-lots. As we have said many times, these data feeds are the fuel of HFT. Last year we highlighted the fact that order id numbers in the data feeds were being used to identify hidden orders. And now we find out that exchanges are supplying their data feed clients with more trade information than the consolidated tape receives.

Ever wonder why HFT always wins? It helps to see all the cards at the table while the rest of the players only see their own cards.