the genesis of an order type by dan aisen, co-founder and quantitative developer at iex

THE GENESIS OF AN ORDER TYPE Daniel Aisen Quantitative Developer, IEX March 14, 2015

2008: Internship at RBC

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Source: h+p://www.wallstreetandtech.com/trading-‐technology/rbc-‐assembles-‐key-‐management-‐team-‐to-‐run-‐e-‐trading/d/d-‐id/1263002?

For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.

Rob Brad

2009-2011: RBC Electronic Trading

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•  Product: a suite of algorithms to trade large orders in the stock market

•  Customer: institutional investors (mutual funds, pension funds, hedge funds, etc.)



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•  Two types of markets where institutional brokers trade stocks:

1.  11 public exchanges •  60% market share •  Publish quotes

2.  40 “private” dark pools •  20% market share •  Don’t publish quotes •  Derive prices from exchanges



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•  Focused on two micro-level trading objectives: 1.  How to buy/sell as much stock as possible

in a given moment (THOR) 2.  How to expose LARGE orders to the

market and have a chance of getting filled without market impact (dark pools)



6 For discussion purposes only. © 2015 IEX Services LLC. Member FINRA / SIPC. All rights reserved.

•  Standard use case for a dark pool: midpoint peg order which floats at the average price of buyers and sellers on the exchanges

Source: h+p://www.itg.com/news_events/papers/AdverseSelecRonDarkPools_113009F.pdf


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•  Two main challenges with resting orders in dark pools: 1.  Getting “sniffed out” (market impact) 2.  Adverse selection (e.g. buying immediately

before a downtick)




Source: h+p://www.itg.com/news_events/papers/AdverseSelecRonDarkPools_113009F.pdf


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•  Two ways a buy order in a dark pool can get adversely selected: 1.  Getting “run over” by a larger seller 2.  A new seller enters the market elsewhere

at a lower price, creating a brief arbitrage opportunity

•  We call the latter structural arbitrage; it only exists because the dark pool can’t update its prices fast enough


THERE’S ONLY SO MUCH A BROKER CAN DO

2012: IEX


2012: IEX Design

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•  Dark pool goal: prevent adverse selection on IEX using a speed bump


2013: IEX Build/Launch

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•  Goal: prevent adverse selection on IEX

•  Launched in October 2013

•  Little/no adverse selection for first several months


2014: IEX

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•  Toward the middle of 2014, as market share grew, so did adverse selection


0%

3%

6%

9%

Jan-‐14 Apr-‐14 Jul-‐14

% Res&ng Orders Adversely Selected

Midpoint Peg

2014: IEX

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•  Our speed bump was effective at preventing after-the-fact arbitrage

•  Orders were now getting adversely selected 1-2 ms before the market moved


2014: IEX

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•  Potential solutions: 1.  Impose stricter throttling 2.  Impose fees for exceeding order/trade

ratio thresholds 3.  Turn off those customers

•  These target the arbitrage traders, but don’t eliminate the blind spot


2014: IEX

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•  Key insight: A price change in the market is not a single instantaneous event; it is a coordinated event across all 11 exchanges

•  Arbitrageurs were trading while the market was transitioning to a new price


USE THE SIGNAL TO PREVENT THE ARBITRAGE

2014: IEX

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•  How can IEX keep up with the fastest traders: •  Speed bump gives us a head start •  Unlike a arbitrage trader, false positives

don’t result in losses •  Introduced a new order type called

discretionary peg: •  Alternative to midpoint peg •  Avoids trading at soon-to-be-stale prices

when market is in transition


2014: IEX

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•  Introduced discretionary peg order type in November: •  1-2% drop in fill rate •  Adverse selection: 9% -> 3%


0%

5%

10%

Jan-‐14 Apr-‐14 Jul-‐14 Oct-‐14 Jan-‐15

% Res&ng Orders Adversely Selected

D-‐Peg Midpoint Peg

2015: IEX

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•  Lessons learned: 1.  Define and track metrics – we could have

responded sooner 2.  Don’t punish the traders; eliminate the

arbitrage opportunity


2015: IEX

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•  Final thoughts: •  It’s the broker’s job to navigate the market

effectively on behalf of their clients •  If an exchange or a dark pool has a blind

spot, not much the broker can do •  Can’t blame someone for trying to profit off

an inefficiency; exchanges and dark pools have the responsibility to ensure they don’t have any blind spots


2015: IEX


Source: h+p://www.nyRmes.com/2014/04/06/magazine/flash-‐boys-‐michael-‐lewis.html?_r=0

the genesis of an order type by dan aisen, co-founder and quantitative developer at iex

Economy & Finance