Flash orders can slow trading down

Discussion in 'Order Execution' started by new$, Oct 6, 2009.

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    The Financial Times Limited 2009.

    Flash orders can slow trading down
    By Larry Tabb
    Published: October 5 2009 00:48 | Last updated: October 5 2009 00:48
    Flash orders have been equated with high frequency trading. That is a false assumption. The main problem with flash orders is that, instead of expediting execution, they actually slow the execution process down by between .03 and .5 seconds.

    A flash order is used in the US when a market order is sent to an exchange that does not have the best displayed price. Instead of immediately routing the order to the exchange displaying the best price, which is required under the SEC Regulation NMS, it is flashed to customers who have the option to trade against the order at, or better than, the National Best Bid Offer before it is routed.

    While some investors want the exchange to find them the best price and time is not of the essence, increasingly for many professionals trading is about determinism – to trade at the price you see or (more likely today) the price the computer sees. They would rather take the price that they see than to wait for a better price - and possibly miss the market completely.

    To accomplish this you need to be the fastest at either setting the price (placing a limit order) or taking liquidity (using a market order to trade against a standing limit order). Flash orders go against this process by slowing orders down.

    Trading technology today is measured in milliseconds (.001 of a second) and microseconds (.000001). Currently the fastest exchanges match orders at 250 microseconds or .000250 of a second. While .03 of a second does not seem long, the flash order delay in comparison to execution speed can equal the matching of 120 orders. This means, while an order is held up waiting for a flash response, a significant number of other orders can move in front of it.

    Besides missing the execution, there is also the question of “what are firms doing with this information?” While specialists and market markers three years ago had advanced information on order flow, they also had rules and restrictions governing their behavior. Unfortunately, many of these rules do not apply to flash order recipients.

    Flash order proponents argue that during the flash period, orders are price- and size-improved (meaning they get a better-than-market execution), and maybe they are. However, the data is not readily available and/or comparable across exchanges.

    The best way to settle this is to either provide comparable execution statistics and allow investors and brokers (who are bound by best execution requirements) to analyse the benefits and opt into these order types, or to move in the direction the SEC is headed – which a ban.

    Without better reporting now, the best we can hope for is a ban. In doing so, we can move toward a more equal and level playing field as the unimpeded flow of information is the best way to foster a fair and impartial market.

    Larry Tabb is founder and chief executive of Tabb Group, a consultancy

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