Tagged: National Market System

Race Condition

You might think today’s title is about physical fitness.

No, ModernIR is an equity data analytics firm, not a personal trainer. I first heard the term “race conditions” used to describe stock-trading at TABB Forum, the traders’ community, in comments around an October 2012 article there by HFT expert Haim Bodek on why high-frequency traders have an advantage.

Reader Dave Cummings said, responding to it, “When Reg NMS was debated, several people very knowledgeable about market structure (including myself) argued against locked, crossed, and trade-through rules because of the side-effects caused by race conditions between fragmented markets.”

Emphasis mine.  You say who is Dave Cummings and what is this jargon that has me wanting to bludgeon my noggin on a wall?

I hope Mr. Cummings won’t mind my resurrecting his point. He started both BATS Global Inc., the stock exchange the CBOE is buying that by market-share the last five trading days nosed out the NYSE with 20.7% of US volume versus the venerated Buttonwood bourse’s 19.9% (the Nasdaq had 17.7%, IEX 2.2%, and nearly 40% was in broker pools), and speedy proprietary (no customers, trades its own capital) firm TradeBot.

He knows market structure.

We come to the jargon. Don’t tune out, investor-relations people and investors, because you need to understand the market to function well in it. Right?

Most people don’t know what Dave knows (that could go on a T-shirt). Mr. Cummings was explaining that trading rules prohibit the bid to buy and the offer to sell from being the same. A locked market. Crossed markets are out too, by law. You can’t make a bid to buy that is higher than the offer to sell.

And this “trade through” thing means brokers can’t continue buying stock at $20 one place if it’s now available for $19.99 another place.

I’ve said before that there’s no such thing as a “fragmented market.” A market by definition is aggregation. The stock market today is a series of interconnected conclaves all forced to do the same thing with the same products and prices. You understand? You can buy Nasdaq stocks at the NYSE and vice versa and only at the best price everywhere.

ModernIR builds software and runs lots of data-warehousing functions so we know race conditions. It’s when something doesn’t happen in proper sequence, you might say.

For instance, a data warehouse must be updated on schedule before an algorithm processes a routine. Some hiccup in the network slows the population of the data warehouse, so the algorithm fails because data haven’t shown up. Race condition.

The stock market is similarly a series of dependent processes, some of which will inescapably fail. Why would we create a stock market with a known propensity for process errors? Exactly. But let’s focus on what this means to investors and public companies.

It means the market is barred from behaving rationally in some circumstances. What if I want to pay more for something? Or say I don’t mind getting an inferior price for the convenience of staying in one place.

Plus, can we trust prices? What if yesterday’s big gains were a product of a race condition? I’m not saying they were. But we measure discrete market behaviors setting prices. Counterparties for derivatives were heavy buyers Monday when the stock market swooned sharply and then recovered most of its losses by the close.

These big banks or insurers bought because investors had portfolio insurance to guard against losses. That’s not investment behavior.

What then if equity trades tied to derivatives didn’t populate someplace and the market zoomed yesterday on a process error? Again, I’m not saying it did.  But the things Mr. Cummings warned would create errors in markets are cornerstones of the regulations behind the National Market System.

And why can’t a bid and offer be the same? Forcing them to be different means an intermediary is part of every trade. That’s why 40% of trading is in dark pools – to escape shill bids by trading intermediaries.

Why would Congress – which created the National Market System – mandate a middle man for stocks, when to get a good deal you cut the middle man out? Think about that with health care (or with government itself, which is the ultimate middle man).

But I digress.

We have a stock market the requires an intermediary, prohibits buying and selling at the same price (unless at the midpoint between them, which is the average, which is why index-investing is crushing stock-picking), and stops investors from paying the price they want and forces them instead to take a different price.

In Denver real estate, the bid to buy is often higher than the offer to sell because there aren’t enough houses. Don’t you want people paying more for your shares rather than less? So why do rules require the opposite?

I want us all thinking about whether the stock market serves our best interests in current form where passive investment is taking over everything.

I’ll be talking about that to the NIRI Capital Area chapter Apr 4, so come say hi. And we’ll be at NIRI Boston tonight self-congratulating with the rest of the sponsoring vendors in Sponsorpalooza.  You all in Minneapolis, good seeing you last week!

I just hope there are no race conditions in our travel plans from Denver today.

Understanding Markets

You’ve heard that bit of cowboy wisdom on how to double your money? Fold it over and put it back in your pocket.

I hear folks wanting cowboy wisdom on market structure. What do I need to grasp? In that sense, this could be the most important Market Structure Map I’ve ever written.

If you’re at home, get a glass of wine. We won’t belabor the story, but it’s not a simple one. In the beginning, in 1792, when 24 brokers clustered under a New York buttonwood tree and agreed to give each other preference and charge a minimum commission, trading securities was simple. That became the New York Stock Exchange. Most trades were for investing, some few for speculating. People have been gambling since the Garden of Eden, obviously.

Step forward. In the 1860s ticker tape by Morse code sped markets up but didn’t change structure. In the 1930s, the Securities Act formed the SEC and imposed a regulatory framework. Structure remained similar, if more process-driven.

Take another step. When Benjamin Graham wrote “The Intelligent Investor” in 1949 (Warren Buffett called it the best book about investing ever written), he said to first distinguish investing from speculating. Seek safety for principal and an adequate return, through research in business-like fashion to find good businesses at a discount to intrinsic value. Own them for the long term. Graham separated this “active” investment from cautious and generalized passive investment. (more…)

Trading at the Speed of Light

When you were a kid, did you lie on your back on the lawn and look for shapes in the clouds?

Nanex finds Charlie Brown and unicorns in trading data. Or maybe goblins and Jack the Ripper. IR professionals should know about Nanex. In Boston last month, I asked for a show of hands from IR folks who’d heard the name. No one had.

Nanex is the electronic microscope for markets, zooming in on trades and quotes in thousandths and millionths of a second. They find shapes, patterns. What Nanex calls crop circles.

These are footprints of algorithms. On September 15, 2011, at hours Eastern Time, Nanex discovered that in one second of trading in YHOO, encompassing some 19,000 quotes and 3,000 trade-executions, a number of trades matched at quotes that didn’t exist until 190 milliseconds after the trades occurred. Nanex termed this apparent evidence of time-travel in trades “0.19 fantoseconds.”

Sure, laugh it up. When asked what might limit it, Illinois Institute of Technology HFT expert Ben Van Vliet responded: “The speed of light.” (more…)

Mad Scramble to Skirt the NBBO

NBBO would be a good name for a rock band. But it stands for “National Best Bid or Offer.” It also appears to be some kind of joke, because everyone tries to avoid it.

The NBBO stems from legislation passed in 1975 by Congress to create a national market system. If you’re already snoozing, you’ll miss the good stuff. You cannot make up stories like this.

Back in the 1900s, several cases involving the NYSE and other exchanges and their proprietary data reached the Supreme Court. In each, the Court held that exchanges possessed an undeniable right to their proprietary quotations.

In other words, where we take for granted now that quotes for stocks are as basic a right as breathing, it used to be that keeping those quotes secret was as basic a right as breathing. (Since our markets flourished then and gasp now, we’d be idiots not to wonder which approach was correct.) (more…)