January 2, 2014
The following is an excerpt from Haim Bodeks ebook, The Problem of HFT -- Collected Writings on High-Frequency Trading Stock Market Structure Reform, available on Amazon. A paper-based version is available here.
Over a good part of the past decade, special order types often were one of the primary topics of discussion between HFT firms and exchanges. Special order types became essential in assisting HFTs exploitation of the REG NMS regulatory framework introduced in 2007, which ironically was intended to strengthen the national market system. Exchanges introduced innovations such as preferential price-sliding and orders that hide and light, which assisted HFTs in circumventing impediments introduced by REG NMS that might have otherwise constrained the growth of HFT.
Such features in themselves might have served to benefit institutional investors if there had not been dramatic differences in order-handling treatment among different classes of order types, practices that created deep asymmetries between HFT-oriented order types and order types commonly employed by institutional investors. Instead, HFTs and exchanges undermined the very body of regulation meant to protect long-term investors from inferior executions in the highly fragmented US equities marketplace. Currently, the bulk of modern HFT volumes are executed with HFT-oriented special order types, accounting for a significant portion of the total US equity market volume.
In light of the growing significance of special order types since 2007, their absence from industry dialogue before 2012 is noteworthy. In fact, in the hundreds of articles, interviews, conference talks, and academic papers that addressed the topic of HFT, there was virtually no mention of the role of special order types in modern HFT until the first quarter of 2012, when regulatory scrutiny of HFT-oriented special order types became public knowledge (SEC Puts Exchanges on Notice Over Computer-Driven Trades, Bloomberg News, April 4, 2012).
Over the period from 2007 to 2012, while an unprecedented flurry of new HFT-oriented special order types were either introduced into the marketplace or revised and updated with new features, scarcely a word was spoken about these developments in the unending HFT debate. There was, of course, no mention in industry dialogue of the importance to HFT strategies of exploiting unfair and discriminatory features embedded in special order types, features that gave HFTs preferential treatment over the public customers (and that were exploited by HFTs in combination with their speed advantage).
More specifically, these innovations resulted in a number of order matching engine practices that served to preference HFTs over the public investor:
Unfair order handling practices that permit HFTs to step ahead of investor orders in violation of price-time priority.
Unfair rebooking and repositioning of investor orders that permit HFTs to flip out of toxic trades.
Unfair conversion of investor orders eligible for maker rebates into unfavorable executions incurring taker fees.
Unfair insertion of HFT intermediaries in between legitimate customer-to-customer matching.
Unfair and discriminatory order handling of investor orders during sudden price movements.
this is a book that could have been read by someone at the SEC. the exchanges disadvantaged investors by preferring HFTs.