Nanex Research

Nanex ~ 15-Nov-2012 ~ Dangerous Order Types

One of the best things you can do to minimize latency on a network is to make sure you don't send more information than it can carry. This basic common sense seems to be lost on the exchanges and regulators. Take Direct Edge's latest proposed order type, the NBBO Pegged Offset Order. Basically, this order type will automatically adjust the price of your order to follow price changes in the NBBO (National Best Bid/Offer). Which means when the NBBO changes price, your order automatically changes price.

Now, what could go wrong with that? What if the NBBO changes a lot: say hundreds or thousands of times a second? Your order would of course change too. Every change causes one or more new messages to be sent on exchange networks. With over a dozen exchanges and thousands of stocks, it doesn't take a rocket scientist to understand that this could flood a network pretty fast. And it could also create a dangerous feedback loop if the networks become unsynchronized, which would happen if they get too full.

Here is a real world example. The stock of Protective Life Corp (symbol PLP) is traded maybe a few hundred times over an entire day. Yet, on November 13, 2012, in one 10 second period, over 21,000 quote messages were blasted across exchange networks (a quote message is basically an order that was sent, but not traded). From the charts, it appears that quotes from 4 exchanges were tracking each other. 

Themis Trading discusses this new order type in their November 15, 2012 blog entry.

1. PLP ~ 10 millisecond interval chart showing bids and asks color coded by exchange. Gray shading is the NBBO (National Best Bid and Offer)
Note how the quotes from different exchanges all react to each other. This is the expected behavior of the proposed new order type - we would expect to see another exchange participating in this algo-induced quote madness. No trades occurred during this period. 

2. PLP ~ 25 millisecond interval chart showing bids and asks color coded by exchange.
Zooming out from Chart 1. Only 1 trade executed over this entire period.

3. PLP ~ 25 millisecond interval chart showing NBBO. Top of shading is Best Offer (ask), bottom of shading is Best Bid..
This is chart 3 without the bids/asks for clarity. Note how the NBBO rapidly flutters in price. Only 1 trade executed over this entire period.

4. PLP ~ 100 millisecond interval chart showing all bids and asks color coded by exchange.
Zooming out by time and price. The charts above detail the first blob of data.

5. PLP ~ 1 second interval chart showing trades color coded by exchange.
Zooming out from Chart 4 to a 1 second interval.

6. PLP ~ Nanex Tick Chart



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