The Need for Trade-At Rule

Impact Technology has on the Market

The liquidity of US Stock Markets have been greatly impacted by the rapid advancement of smart computer algorithms working in conjunction with ECNs (Electronics Communication Networks), ATSs (Alternative Trading systems) and Dark Pools.  The automation of smart computers along with liquidity in off exchange venues has contributed to a dramatic increase in trading on these alternative venues and have caused quite a dramatic decrease in volume traded on registered exchanges. 

It is this high speed coupled with the choice of using an ATS for fast execution and low cost that was a catalyst to what we now refer to as High Frequency Trading (HFT).  HFT firms incorporate the speed from smart computer algorithms which gives them the ability to see orders in process, and buy them up for themselves.  Since they can see all pending orders, they know if they’ll be able to turn around and sell at a slightly higher price, even in the sub-penny price range.  On high-volume orders, fractions of a penny add up to millions of dollars. 

Sub-Pennying

This combination of speed from computers and liquidity in ATSs, added to the decimalization of the markets in 2001 has spurred another predatory practice referred to sub-pennying, which goes right along with HFT, and occurs regularly today. 

Sub-pennying occurs when a broker gets in front of a displayed order by 1/100^th of a penny, or .0001.    This is all done inconspicuously with a computer algorithm program that allows them to see an order is pending, so they’ll buy up shares within a sub penny difference.

Sub-Penny trades occur because POF firms have to validate taking the trade for themselves, so they improve the price by .0001. The market is showing $10.00 x $10.01, so when an order comes to the POF firm to sell at $10.00, they fill it themselves at $10.0001, letting them claim they improved the price for the customer. The truth is that there is probably a bid in a dark pool at $10.005, that the POF firm will then sell, immediately making themselves .0049/share in the process. Even if there isn't anything in the middle that they can immediately get out of the trade, they are far from the bid, which is what all bidders in the market at $10.00 wish they could be.  All other bidders  never get the chance, however, as the POF firm steps in front of them without ever having to risk putting a bid into the open market.

This leaves traders experiencing whiplash in a scenario of “here one minute (second in this scenario) and gone the next” when attempting to execute their orders.  

Most traders that we talk to agree – a Trade-At Rule is necessary.

Headquartered in Chicago, Great Point Capital, LLC, is a member of FINRA and has been serving the trading community since 2001. Our mission is to be the leader in the equity day trading community by giving the best traders the tools and support to make the most of their trading careers.  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.

Regulation on Payment for Order Flow

Payment for Order Flow (POF) is the cunning practice of many third-party firms that pay brokers to send them their trade orders, many retail trades, instead of sending them to the open market.

The POF firm can then either take those orders and execute themselves, or they can pass it on to the market to fill against existing quotes.  As the typical retail investor is basically uninformed and do not see the real-time market prices, POF firms love receiving retail trade.  When they sell  to the customer they may offer a price improvement of 1/100^th of a penny, giving the appearance of a price improvement.  In reality, they may have already seen that the NBBO is moving downward, so they’ll jump in front of it and make the execution at the current higher price, then immediately buy it back at a discount.

They also may find it in a dark pool at an even greater discount.  Furthermore, firms paying for order flow are using high speed direct data cables, allowing their computer algorithms to pick up on the price change fractions of a second before its represented in the NBBO.  This speed advantage coupled with the guaranteed order flow creates a liquidity problem for daytraders, who can only trade what’s left of the POF and High Frequency Trading (HFT) firms. 

Current Regulation

When it comes to payment for order flow, disclosure is the main approach taken by the SEC.  Rule 10b-10 requires broker-dealers to reveal that a payment for order flow arrangement exists on their customer’s statement.  They are not, however, required to disclose information regarding the source or the nature of the compensation received, unless the customer submits a written request. 

It is doubtful that customers are even reading the fine print or the quarterly reports, and even more unlikely that they’ll submit a written request asking about the payment arrangement. 

Brokers are required, however, to complete the trade with the “best execution”, and at the best NBBO price.  This is what can create a conflict of interest.  Some exchanges offer different pricing models, which could be incentive to some brokers to look for the best price under the NBBO, but they may also search out the best rebate available to them. 

Rather than just require disclosure, perhaps the implications to the investor, the market and all traders should be reviewed further.  The benefit to the broker is obvious – rather than incur an expense to trade, they enjoy a robust profit center.  How does this benefit the firm paying for order flow?  The advantage of a first look at orders before displayed on the market is the clear advantage here, it’s what allows them to pay for order flow and still turn a profit.  Does this elite privilege come at a cost to the market and investors?

This particular topic has generated a lot of attention as Senator Carl Levin has called for a complete elimination of the practice.  Of course Michael Lewis and his best-seller “Flash Boys” contribute to raising awareness to this and various other questionable Wall Street practices. 

Most daytraders that we talk to agree with Senator Carl Levin and Michael Lewis in that Limits on Payment for Order Flow are long overdue!

Headquartered in Chicago, Great Point Capital, LLC, is a member of FINRA and has been serving the trading community since 2001. Our mission is to be the leader in the equity day trading community by giving the best traders the tools and support to make the most of their trading careers.  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.

History of Payment for Order Flow

One thing stands out as a thorn in the side for daytraders, Payment for Order Flow (POF).  POF has been present in United States markets for quite a long time now, as it is a common practice going back to the 80’s where master manipulators like Bernie Madoff fine-tuned the practice for the benefit of POF firms.  POF occurs when a third-party firm pays a brokerage firm to send their orders to them, rather than to the open market.

The POF firm can take the order and either execute it themselves, or pass it on and send to the market for fulfillment against other existing quotes.  The majority of the trades passed onto POF firms are retail trades, which POF firm especially enjoy, as the retail trader is not as knowledgeable of the market and its inner workings.  The typical retail trader does not see true-real time market prices and they remain relatively uniformed. 

Current Regulations

Rules 10b-10, 606 & 607 under the Exchange Act dictate that when these transactions occur, the broker-dealer is obligated to disclose the agreement in public quarterly reports, and also to the customer.  The broker is also required to execute the trade with the best price according the National Best Bid and Offer (NBBO) and with the “best execution”.   

This has the potential to create a conflict of interest, as some exchanges utilize different pricing incentives to brokers to not only look for the best price at the NBBO, but also to trade where the rebates are greatest to them. 

Implications to Traders and Investors

When the typical American consumer places their retail trades from home in the evening, they may stipulate that they’d be willing to pay up to $20.10 for a share of XYZ Stock.  The firm buying these orders can see what they want, and they can see that the NBBO is at $20.09 x $20.10.  This is where they can pass the order onto the public markets and buy the $20.09 offer, or it’s more likely that they will sell the stock to the customer from their own reserves at $20.0999, to give the appearance of improving the execution in return for jumping in front of every other offer at $20.09.  They now are just inside the bid and have the possibility of midpoint pricing in dark pools to buy it back at $20.095.

Role of Technology

In addition to this, POF firms utilize quick direct feeds to see the market milli-seconds before it is available in the NBBO.  In the above example, this means it’s possible that the market has already moved from $20.08 x $20.09.  If the NBBO is still displaying an offer of $20.10, they can give the execution at $20.10, which is the best official offered price, and immediately buy the $20.09 offer they know is coming. 

Even when the buy-sell difference is a fraction of a penny, do not be fooled, this is a multi-billion dollar industry available only to the select few.  

This practice hurts the average day trader as the POF firms process all of the uniformed retail customer orders first, leaving the informed flow as all that’s available to be absorbed and traded by the exchanges. 

Another frustration for daytraders trying to sell at their $20.10 price is that they act as nothing more than a pricing reference point for firms that see the orders first.  The trader only gets to sell at the $20.10 price if the firm seeing their order decides not to sell it themselves, which would likely mean that it is not a good trade any longer.

If you are an experienced, hard-working trader frustrated with your ability to get quality executions, Limits on Payment for Order Flow is probably high on your Wish List.  

Headquartered in Chicago, Great Point Capital, LLC, is a member of FINRA and has been serving the trading community since 2001. Our mission is to be the leader in the equity day trading community by giving the best traders the tools and support to make the most of their trading careers.  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. 

Implications of Payment for Order Flow

Payment for Order Flow (POF) is a common practice that has been occurring in the United States markets for a long time now.  This practice, in fact, was happening in the 1980’s with master crafters Bernie Madoff taking the front lead.  The arrangement of POF occurs when a third-party firm pays a broker to send orders including a large amount of retail orders to their firm instead of to the open market. 

When the POF firm gets their orders, they can either pass it on to the market to be filled against existing quotes, or they can execute it themselves which is more probable.  If the buying firm sees an order for $10.10 for example, they can sell the stock to the customer themselves for $10.0999, giving the appearance of giving a price improvement.  Now they’re just inside the bid and they can take advantage of midpoint pricing in dark pools and can possibly buy it back for $10.095. 

Direct high speed data cables connected directly to exchanges allow their computer algorithms to pick up on the National Best Bid and Offer (NBB) fractions of a second before it’s widely represented, allowing them to see a move to possibly $10.08 x $10.09.  If the NBBO hasn’t changed yet and is still showing an offer of $10.10, they’ll give the execution at $10.10 adhering to the best official offer price, and turn around and buy immediately the $10.09 offer they know is coming. 

The implications to the average day trader are that they are the last to have their orders executed because once the POF firms process their orders including all retail customer trades, traders are left searching for what’s still available. 

All too often, when day traders try to sell stock at $10.10 referring to the example above, they act as nothing more than providing a reference price for the firms that get to see the orders first.  Typically, the only way that the daytrader gets to see at the $10.10 price is if the POF firms decide not to sell it themselves, which means in most cases that it’s no longer a good trade.  This is quite a disadvantage.

After talking with several experienced daytraders, the consensus is in, and most daytraders agree that a Limit on Payment for Order Flow would be on the top of their wish list. 

Headquartered in Chicago, Great Point Capital, LLC, is a member of FINRA and has been serving the trading community since 2001. Our mission is to be the leader in the equity day trading community by giving the best traders the tools and support to make the most of their trading careers.  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.

Regulations and Trade-At Rule

RegATS, RegNMS and the effect on Markets

RegATS was established in 1999, and actually increased the popularity of ATS (Alternative Trading Systems), as they then became allowed to register as a broker dealer, rather than as an exchange that must adhere to more stringent rules. This caused the volume traded on ATS systems to increase, having the opposite effect on the markets as they quickly lost liquidity. 

The SEC responded in 2005 with RegNMS, which was aimed to unify and streamline the ATS market share by requiring that all orders coming from an ATS be routed through a national market system, creating one combined network. 

RegNMS also required that all exchanges route all orders, regardless of where they originated,  to the trading venue with the best displayed price, which did not necessarily have to be on an exchange. 

These regulations dramatically decreased the strong position that exchanges had on the market, as they lost even more liquidity.  Prior to RegNMS, for example, the NYSE traded approximately 85% of total market share, while after RegNMS that volume dropped to about 30%, and went as low as 20% in 2014. 

Trading in ATS venues and Dark Pools was even more attractive with these regulations, along with a loophole in RegATS which allows trading with hidden prices as long as the total volume of those trades is less than 5% of the volume trading of the stock nationally.  Investors were allowed to go into dark pools and trade anonymously to avoid alerting the HFT firms of what their intentions were.  As more and more investors went to dark pools, exchanges again lost market share. 

SEC Begins a Tick Size Pilot Program to address Trade-At Rule

Various proposals have been addressed to the SEC as options to implement a Trade-at Rule to address the liquidity of the markets and off exchange trading.  One proposal referred to as a Tick Size Pilot Program is in process currently and will evaluate the effect of widening the tick size.  Under this pilot program, the tick size will be increased from one cent ($.01) to five cents ($.05), only on certain piloted securities. 

Three groups and one controlled group were put into place, each with separate rules to trade by. One of the groups is actually using a trade-at rule, while another is required to quote in increments of $.05, and yet another must quote and trade in $.05 increments. 

This Tick Size Pilot Program just started last year in October of 2016, and is schedule to run for two years  For more information on this pilot program, and to receive email updates of the program, visit FINRA.org.

Other systems proposed include the “Grand Bargain” which was suggested by the Intercontinental Exchange, ICE, which suggests a trade at rule combined with reduced access fees 

Another proposed plan by Nasdaq suggests merely a decrease in fees with no trade-at rule at all. 

Our View on Trade-At

Currently the trader's public quote acts as a reference price for POF firms and dark pools to trade in front of him.  If a trader decides to display a quote in the public markets, that trader should get executions when orders come in at or through his displayed price.  The trader only gets executed once POF firms do not feel there is an advantage any longer at that price.  This means that the trader that risks the most in displaying a bid or offer is the last to be filled at that price.

That is not a fair system, and de minimis price improvements should not be used to justify the practice.

Most traders competing with this pricing model agree – a Trade-At Rule is necessary.  

Headquartered in Chicago, Great Point Capital, LLC, is a member of FINRA and has been serving the trading community since 2001. Our mission is to be the leader in the equity day trading community by giving the best traders the tools and support to make the most of their trading careers.  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.

Development of the Need for Trade-At Rule

US Market History

Many events have occurred in modern history that have created what many feel is a need for a Trade-At Rule.   Common practices such as Payment for Order Flow (POF) are causing Exchanges, Regulators and Traders to analyze the current structure of the market and to consider implementing a Trade-At Rule.  

Payment for Order Flow is the agreement that exists when a third-party pays a broker to send their orders to them, rather than to the open market.  This is a cunning strategy we are all well aware of, but yet there seems to be quiet acceptance.  This type of payment incentive developed over time with the introduction of Alternative Trading Systems (ATS) and rapid improvements in computerized algorithmic trading.  This type of payment structure leaves traders fighting for market share.  

Change in Markets due to Advancements in Technology

The combination of ATSs and other off exchange venues along with computerized algorithmic software have had a huge impact on US Markets and how securities are traded today.  Daytraders today dream of a level playing field and efficiency in the market.  

The Stock Exchange of today is not occupied by clamorous traders shouting on the floor while waving papers in the air.  This market today is an age of computer algorithms scanning all available exchanges to buy and sell desired shares in fractions of a second.  

Many of the trades occurring are on an off-exchange venue such as an ATS, an ECN (Electronic Communication Network), or a Dark Pool, where they can act like an exchange but adhere to their own rule set.  These off-exchange venues often offer price improvement, fast execution, and decreased trading costs for investors, making them a desirable way to go.  

This is where a conflict of interest could develops to the firms processing these orders.  Brokers can either route their orders to an off-exchange venue offering the best price with the least costs, or they can send their orders to the venue that pays them the best rebates.  

The introduction of various ECN’s, ATS and Dark Pools has contributed to the development of a fragmented market that now consists of thirteen US Stock Exchanges, over forty dark pools and several ECN’s to choose from.  With so many choices, it is no wonder that people are talking about liquidity, paying for it, and wondering how to keep it flowing within regulations, and in an ethical manner.  While traders are fighting for market share, and wondering where to find liquidity in the market, most traders are also wondering if it’s time for new regulations, or are they long overdue?

Headquartered in Chicago, Great Point Capital, LLC, is a member of FINRA and has been serving the trading community since 2001. Our mission is to be the leader in the equity day trading community by giving the best traders the tools and support to make the most of their trading careers.  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.