interesting comments of Mr. Bright of Bright trading! http://www.sec.gov/comments/s7-02-10/s70210.shtml Lets voice our opinion on HF scum robots and such! Excellent response from Bright trading: http://www.sec.gov/comments/s7-02-10/s70210-63.pdf Robert W. Cook Director, Division of Trading and Markets Securities and Exchange Commission 100 F Street, NE Washington, DC 20549-1090 Re: Meeting with Bright Trading, LLC on Equity Market Structure Dear Mr. Cook: We appreciate the opportunity to provide our comments, and address the Division of Trading and Markets, on File No. S7-02-10, the Commissionâs Concept Release on Equity Market Structure. We commend the Commission for taking the initiative to evaluate the current equity market structure. Bright Trading, LLC is one of the largest professional stock trading firms in the United States with hundreds of traders trading from offices and connected remotely from their homes. Bright has been registered in the US as a broker dealer with the Securities and Exchange Commission since 1992 and is also a member of the Chicago Stock Exchange. Bright is in the business solely for trading its own membersâ accounts and does not solicit nor accept orders from customers. All transactions are executed through our clearing broker, Goldman Sachs Execution and Clearing. In order to become a trader at Bright, each individual must become a Class B member of the limited liability company and must successfully complete the Series 7 general securities representative qualification examination as well as be registered with the Chicago Stock Exchange. Bright Trading has noticed a number of changes in the equity market structure over the past few years. While some of these changes have benefited the overall markets, other changes have raised significant concerns for us. We have outlined a number of our concerns with the current market structure below. Underlying Problem: Undisplayed Trading Centers Compromising the NBBO through Sub-Penny Trading Sub-pennying An abusive strategy that has been occurring with increased frequency is a practice called âsub_ pennyingâ. It is the practice of a market participant stepping in front of a displayed limit order by a fraction of a cent. The explicit purpose of this strategy is to preempt the NBBO. Evidence: Appendix A, B, C, D, E, F, G, H, I. SEC rule 612 prohibits market participants from displaying orders in a sub-penny increment. Most broker-dealers will not even accept these sub-penny orders from their customers. Broker-Dealer Internalization However under SEC Rule 612, broker-dealers themselves are allowed to provide âprice improvementâ to their customers. When an investor places a market order from their retail brokerage account, their broker-dealer routes this order to their OTC market maker. The market maker then decides if they want to trade against their customer, by taking the opposite side of the order. If the market maker believes they can make money by trading against their customer, they will fill the order from their own inventory. In this case, the market order never makes it to the public exchange. This practice is known as broker-dealer internalization. Statistics from the Commissionâs Concept Release on Equity Market Structure, state that 17.5% of all trades are internalized by broker-dealers. A more alarming statistic from page 21 of the release states that, âa review of the order routing disclosures required by Rule 606 of Regulation NMS of eight broker-dealers with significant retail customer accounts reveals that nearly 100% of their customer market orders are routed to OTC market makers.â This means that almost every single market order placed in these retail brokerage accounts, is checked by the broker_ dealerâs OTC market maker to decide if they can make money by trading against their customer. They can legally trade against their customers as long as they match or beat the National Best Bid and Offer (âNBBOâ). Nominal Price Improvement Broker-dealers will often beat the NBBO, by a nominal amount, often as little as 1/100th of a penny. This gives them justification for internalizing the trade, because they saved their customer a fraction of a cent. But this savings does not justify the cost to the true liquidity provider that was left unfilled. To put this into perspective, consider a stock offered at $25.00 on the public exchange, the best posted ask price. An investor buying 100 shares of this stock would pay $2,500.00. When the broker-dealer internalizes the fill, and beats the NBBO by 1/100ths of a penny, the investor only pays $2,499.99, a savings of 1 cent. This nominal price improvement of 1 cent, does not justify the unquantifiable loss of the lost trading opportunity, to the person who was publicly offering the stock at $25.00. This person, the true liquidity provider, is left holding the stock. Evidence: Appendix J. Dark Pools Being Used To Hide in Front of the NBBO If the broker-dealer decides to pass on the opportunity to trade against its customer, the order is routed to the exchange. Many broker dealers use smart routers that check âdark poolsâ of liquidity for a better price. A dark pool is an execution venue that provides liquidity, but does not provide public quotations. In other words, it is a place where a trader can place hidden orders. Algorithmic programs can place hidden orders that automatically sub-penny the NBBO. This can be easily done by pegging the order to the NBBO, with a sub-penny offset. For example, the NBBO offer from the above example was $25.00. An algorithmic program can be created to peg a sell short order to the NBBO offer with a -.0001 offset, and be sent to a dark pool. Even though the public NBBO offer is $25.00, the algorithm has a hidden sell short order at $24.9999. If the public offer were to move down to $24.99, the algorithmic program automatically adjusts its offer to $24.9899. In essence, the algorithmic program is always hiding in front of the NBBO. This sub-penny order does not violate SEC rule 612, because the $24.9899 order is not displayed. A market order that was sent via the smart router searches out the better price and is executed at the hidden $24.9999 price. Again, the displayed liquidity provider is not filled. Evidence: Appendix H, Appendix I. Discouraging Liquidity Providers The only time the displayed order on the NBBO is filled from an incoming retail market order, is when the OTC market maker of the broker-dealer passes on the chance to trade against its customerâs order, and there are no undisplayed orders hiding in dark pools in front of the NBBO order. As a result the only retail orders getting through to the publicly displayed NBBO, are the orders that the first two market participants have passed on. If the first two participants have passed on the opportunity to trade against the order, there is a good chance that the incoming market order is on the right side of the market (in the short-term). Hence, the only NBBO orders that are filled are those that are more likely wrong (in the short-term). The displayed liquidity provider is âsub-penniedâ when theyâre right, filled when theyâre wrong. As liquidity providers become discouraged, they will place fewer passive limit orders in the short term and ultimately leave the trading markets. This will lead to less depth in the market and larger spreads, both increasing the cost to investors in the long term. Algorithmic systems being used to Preempt NBBO in displayed market centers Another predatory practice that is extremely prevalent in our current market structure, is displayed âpennyingâ, where an algorithmic system automatically steps in front of a displayed order by a full cent. The reason for this practice, is to be first in line for execution. While this practice is an annoyance to active investors, and active traders, it is not as damaging as the âsub_ pennyingâ that goes on in the undisplayed market centers. This is a predatory practice that is extremely prevalent in thinner issues, as the typical bid-ask spreads are much wider than 1 cent. This problem does not exist in the most actively traded issues. This could however become a serious problem, if the public exchanges are allowed to quote in sub-pennies as well. Sub-Pennies for Everyone â Not the Answer The public exchanges have recently disclosed their interest to quote in sub-pennies. They need a level playing field to compete with the undisplayed market centers (broker-dealer internalization, and dark pools), so they are proposing a move to displayed quotes in 1/10th of a penny increments. This is simply not the answer to the sub-pennying issues.
I believe that the sub-penny consideration is for stocks under a certain dollar value. A one-penny spread on a $3-$5 stock (look at C or ETFC) is a much higher percent of the notional than a one cent spread on a name like Google or Apple. By allowing exchanges to quote in 1/10th of a penny for stocks under a certain value you decrease the spread so that 1/10th spread on a $3 stock is equal to a one penny spread on a $30 stock. It reduces the cost of trading by tightening the spreads and in my opinion is a good thing for the average investor. The Bright comments are factually accurate but are lacking the full scope of internalizing orders to an OTC matching engine. Iâm not sure if the true Market Making (MM) practices were intentionally left out, or perhaps that Bright does not understand. The Retail arena is skewed against the Retail Investor through commission and fees primarily but also through technology and access to information. The fee structure at virtually every retail brokerage firm is set up in such a way that sending auto-routed market orders is by far the cheapest way to execute a trade. Auto-Limits are then the next price point above and exchange specified limit orders are always the most expensive. By having a structure like this I think the point that Mr. Bright missed is that many internal OTC desks will take the other side of your order and then cover their side with the hidden liquidity inside the spread (if you are buying 100shs @ $25 they fill you @ $25 essentially leaving them short 100shs @$25 and then they cover their short with the sub-penny or full penny inside). Most internal/retail OTC MMs use market-neutral strategies that match orders against their own book or seek outside liquidity to offset orders in a cost effective manner. Forcing the Retail investor to submit auto-routed (internally matched) market orders through fees is essentially forcing the Retail Investor to give up the ability to play on a level playing field. Market orders can be held for a set amount of time before being forced to execute at the NBBO which gives the OTC MM a chance to seek out a better deal for them before executing your trade. The only true solution is to give the Retail Investor direct market access and eliminate OTC market making. Technology and access to information is also limited in the retail arena as compared to even retail prop or institutional prop desks. Most of the large Retail Brokers in the US do not provide quotes from all exchanges to their customers which make the book appear to be thinner than what it actually is. This combined with sub-par delivery of quotes and large/heavy execution platforms delays the real-time market feed leaving the Retail Investor exposed to a less than optimal trading arena. I agree that sub-penny trading often leaves the true liquidity provider holding the shares (which is a bad thing), I do not agree that the Retail Investor should be given full access to the market place equal to that of Registered Traders and Brokers. Dark Pools also exist for a reason â and for very good reason in my opinion, and perhaps the solution is to hold them to the same standards as the pubic exchanges â disallowing sub-penny orders while still allowing them to remain dark. The Retail Investor should not be in the speculation or day-trading space so with that in mind, the small price improvement that they see from sub-penny trades is a good thing for their overall portfolio and since it is such a small portion of the overall volume it has little impact on the Institutional/Prop traders. It seems to me that Brightâs comments are skewed to favor the Day Trading and manual speculation arena rather than that of an equal marketplace. Most traders know that there is hidden liquidity inside a spread and most use that to their advantage. I donât agree with the opinion that sub-penny fills are wrong and NBBO fills are right (in the short term) and I donât buy the implication that the liquidity providers and Retail Investors are getting the short end of the stick â a Lead Market Maker (LMM) is required to be at or better than the NBBO a set percent of the time and registered MMs by law cannot intentionally fill outside the NBBO. Its complicated and there is an institutional edge that is being exploited however I find it very hard to make the leap that Institutional Sub-Penny Trading is hurting the Retail Investor. The changes in the marketplace (boxes) make it much harder to be a manual trader today but I donât know that the learning curve today is any more or less steep than it has been over the last 10-15 years given the amount of technology improvements, introduced efficiencies, and execution improvements. It seems to me that understanding how the system works puts you on an equal playing field to choose how you would like to trade/invest.
I agree with Winston's comments. I also somewhat agree with Mr. Bright's, but think they rest on a flawed assumption. My counterpoint is this: the displayed liquidity provider is not owed much, other than priority over other orders placed at the same price "behind" / after him (and this is only in the case of matching rules using price/time priority... pro rata is a whole different thing in the futures markets). Posting an order / placing passive liquidity is nothing like it used to be; as markets have matured it's aggressor orders that create informative prices. Now, I said "not much", not nothing. Subpennying is a problem, not because subpennies themselves are problems, but because the current rules allow for price improvement. As Winston said, subpennies can make a large notional difference on low-priced securities. That's legit. But what is price improvement really? Limit orders and market orders, as well as passive and active / aggressor orders, all have elements of (long and short) optionality. (See Harris' Trading and Exchanges if that doesn't make sense to you.) If I post an offer of $4.20 in C, and a customer sends me an order to buy at $4.20, the ability to fill him on my own at $4.199 is an option. Without going way overboard on this topic, I'll just say it's pretty clear to most people that paying only $0.001 to exercise that option (by electing to internalize) is a FANTASTIC bargain, not to mention that the original option was granted (for free, in a sense) by the sender of the order. So in my opinion, the "not much" a passive order is owed is a system where the costs of improvement on its price are more appropriate for the potential gains. This is closely related to the Flash trading stuff. As Winston says, there are and almost always should be "tiers" of players in the markets. But some advantages are just egregious and therefore abusive. I'll offer this, superficially unrelated: flash trading and subpennying are chickenshit compared to what the Street really cares about. You think they're worried about prop trading? Wait until the SEC wakes up and thinks about internalization.
Bright addresses internalization and payment for order flow problems in their second letter to SEC. http://www.sec.gov/comments/4-602/4602-29.pdf
All I can say to that comment is: bravo. I can find nothing material to disagree with. Thanks for posting it. (Of course that's kinda easy to say when a lot of what I said is in there... agreeing with myself is fairly easy.)
I'm not sure that I agree with that comment. The uninformed orders pay the least and the informed orders pay more? I get where he is going with the comment - but still informed vs. uninformed sounds like another BS ploy to argue against internalized orders. Bright also is very vague about what is retail, who internalizes orders, etc. I'd like to see someone quantify the amount (if any) that spreads have widened due to dark pools. If dark pools have truly widened spreads then there is an argument, if they haven't then it's just Bob crying about the dying manual prop business. Uninformed to me seems pretty informed. Why would you call someone informed when they intentionally try to pay more for an order?
I don't read it the same way. In the example, all the orders try to pay the same price. The difference is that the informed orders try to pay that price with the knowledge the better prices aren't available, and the uninformed just pay what they see as the ask. Assume you are the MM, I am informed, and Joe Blow is uninformed. Joe Blow decides he wants to buy, and just presses the 'buy market' button, without knowledge or access to what else is available. You get his order and have many options as to what to do with it. On the other hand, when I send you an order, it is with full knowledge and capability--meaning I've already surmised dark liquidity isn't available, etc. In both cases, you as MM (assuming you can internalize) have an option. But in the case of my order I've already determined it's not worth much, and you're therefore unlikely to exercise it. My order is much more likely to go to another NBBO offer. The comment (roughly) states that NBBO offers made by non-internalizing participants can only fill my orders, and never Joe Blow's. And I do agree that sucks--non internalizing participants have a much bigger adverse selection problem.
So the uninformed investor consists of everyone without access to dark pool liquidity - or everyone who does not have complete & total access to market liquidity? The issue I have with that is that it lumps Retail and Professionals together and to qualify as an informed investor you need to be a top-tier Institutional MM or Prop Desk (and I mean GS prop not the lower tier prop most of us know). I understand how the article was intended to be written however I still think that the use of uninformed/informed are being used in such a way as to vilanize the Institutions and make Bright's prop desk look closer to Uninformed Retail (which it might be for all I know). I don't subscribe to dark pools because I don't need it for my trading however I did at one point to check some of them out and it wasn't any help at all. Because I choose not to see the hidden liquidity am I still uninformed even though I know its there and I know I can trade it? At the lowest level, the Retail Investor at a Retail Broker could be considered uninformed however sub-penny trading actually improves their fills. Remember when a MM would let your order sit out there for long enough for the person at the front of the book to pull their order back a penny so you would get pennied up/down the book - those days are now gone and you are getting pennied to the inside which is better for the Retail guy. Furthermore the true Retail Investor should not be Day Trading or Speculating. The current system of Internalizing is much better than the days of phoning orders into a broker who would front run your orders or sit on them for 30min to make a bigger rip. At the lower prop level - yes I believe that people are getting hurt over this but they are licensed professional traders and I have zero sympathy for them. Don't complain about the rules in a game you chose to play. I know there are many traders at Direct Access Brokers that are left holding shares when they should have gotten a fill - but then again that is a dying breed of trader due to market evolution. It makes it harder for new people to learn and suceed just as it makes it harder for existing guys to stay in the game. Because of this that sector of trading has declined and I doubt anyone really thinks the Manual Trader will have a revival and see numbers equal to 10-15 years ago. I think the comment letter pushes the informed/uninformed skew to favor everyone except institutions which is wrong and unfair. Anyone who is a licensed/registered trader should know enough that the line should be drawn between trading through a Retail Broker and Professional Direct Access Participants.
I sometimes swing trade the stock FRO , this is what normally happens: example : bid 33.50 ask 33.53 i want to buy at mkt so i hit the mkt buy button , and i get filled at 33.54 why didnt i get filled at 33.53? it is not a one-off it has happened many times other times i might want to use a limit order and get between the spread 33.50 33.53 - i put in a limit to buy at 33.51 , then the bid jumps to 33.52 and ask jumps to 33.55 and so i cant get filled if someone hits market sell I feel I'm being cheated. Dirty rotten scoundrels!
I see why you're saying this. But the market is better off with a healthy amount of decentralization. One of the things we learned on May 6 is that most of the liquidity in the market now is provided by a relatively few number of institutions. There's nothing wrong with that; after all, for decades on NYSE stocks basically one person got to do that. But the problem is the new liquidity providers have no requirement to make sure there IS a market. So they squeeze out weaker players, and then when they don't like what they see, they can just shut off their systems. So I want those "little pros" to feel like they have a shot and do well enough to stay involved. My heritage is as a pit guy in Chicago. I spent some time in NYC on the AMEX options floor in the late '90s and HATED the specialist system. In most crowds in those days there were 2 or 3 people who would actually make a price (rather than being a "handraiser"). As one of them it was incredibly frustrating to have a broker come to me for a market, but when a trade took place the specialist took 30-40% just for being there. I feel essentially the same way about internalized orders (although one could argue the barriers to entry are lower--you just have to get flow). I don't like flash orders, internalization, or price improvement. While I understand the use case for dark pools (I've never bothered to access them), I tend to think their benefits are outweighed by their costs to transparency. Overall, I just think there's a structural problem with a system where someone can take the risk to post a price, and then watch others execute that price (or 0.0001 better or whatever) with no ability to participate. It's a worthwhile goal to, in general, make that happen as little as possible. Markets should revolve around one simple rule: post your prices and trade on them. That's how the manufacture and dissemination of economic information best takes place.