Monday, May 29, 2017

How Latency Arbitrage Affects the NBBO


Latency arbitrage is a result of several factors including co-location, HFT, flash trading, and SIP latency, all with their own consequences to the marketplace.  Latency arbitrage, however, has a direct effect of contributing to an altered NBBO.  The National Best Bid Offer, (NBBO), is supposed to be the one accurate price of a stock across the entire market, from all exchanges and off exchange venues. It is intended to be a representation of the “best price.” The problem with this intention is that it is impossible to instantaneously update every single participant in the market, even the national exchanges, at the very moment when a change occurs to the NBBO.  
Information about all stock price changes need to travel among all market participants and the speed at which that occurs varies greatly depending upon the distance between the firms, and the technology a firm is using.   This means that all market participants, including the national exchanges themselves, see a different view point of the NBBO at the exact same moment in time.  This information leakage is not the only pitfall of latency arbitrage.  When these privileged firms execute their privileged trades, the NBBO is actually altered by these front-running executions.  
There may be no quick solution to this latency problem, and maybe not even a long drawn out solution, but there are some tools available now that offer some assistance to traders dealing with this problem.  If we cannot stop the latency arbitrage as we know it, we can tackle it another way – with modern day latency arbitrage tactics.
One tool addressing this very issue is the IEX Signal that is used in their proprietary D-Peg® and Primary Peg orders.  The signal acts like a yellow traffic signal, warning a trader of an upcoming change to the NBBO.  Used for a predictive tool, this IEX signal is utilized in these proprietary orders, and is also termed a ‘crumbling quote indicator’.  It predicts an upcoming price change to the NBBO, basically by observing a stock’s NBBO activity, any changes in that price, and then compiling a prediction of which way it’s moving.  IEX’s signal predicts the upcoming NBBO change, and moves their D-Peg orders out of the way, protecting the investor.
This may be one small tool in a very large fight against a long-time practice, a practice the privileged participants are not willing to give up too easily.  With a computer algorithm conducting trades at lightning speed, we all must realize that we are now at a crucial point in the structure of our financial markets. Latency arbitrage must still be tolerated, although the time has come to take action whenever possible.

Great Point Capital has been serving the trading community since 2001 and our 100+ prop traders actively trade the firm’s capital, specializing in equities and equity options.  We are headquartered in Chicago with a location in Austin, TX.  Contact Great Point Capital LLC today, in either our Chicago Office, or our Austin Office, to learn more about how we can successfully trade together with high performance results.  We are one of the very few firms able to offer access to Takion Software Platform, enhancing your online equity trading performance.

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