Nanex Research

 Nanex ~ 08-Jan-2013 ~ Locked and Crossed NBBO
On January 8, 2013 there were two separate events where an exchange stopped disseminating quotes, which caused the last quote sent from that exchange to lock (bid price equals ask price) or cross (bid price is greater than ask price) the NBBO (National Best Bid/Offer) when market prices moved higher or lower on other exchanges. Crossed quotes cause many problems for wholesalers (who internally match orders), order-routers, traders, financial web-sites, business news channels, and any of the 2.5 million subscribers that use the consolidated quote to analyze stock prices.

Market Stability

In August 2012, we made a fascinating discovery: whenever the NBBO crosses in a stock, several dark pools will stop reporting trades and wholesalers (internalizers) will stop matching customer orders (you can read that paper here). Because the SEC looked at flash crash data with mostly 1 minute snap-shot data, they concluded and wrote in the final flash crash report that internalizers stop matching retail customer orders when stocks have large price moves. But this is untrue. Internalizers only stop matching customer orders when the NBBO crosses in a stock. Which makes the integrity of the consolidated quote extremely important in maintaining market stability.

NYSE Outage

The first event began at 14:10:30, when NYSE's quote stopped updating in symbols within the alphabetic range SJ through TCZ. Within 31 seconds (14:11:01) the NBBOs of 35 of these stocks began to lock and cross as prices moved away from NYSE's stale bid or offer. NYSE finally cleared their quote at 14:19:29 which removed their last posted bid and offer from consideration as the NBBO: this had the effect of unlocking/uncrossing NBBOs in those stocks, allowing the market to resume normal trading. NYSE began quoting and trading in these stocks at 15:05:33.

NSX Outage

The second event began at 14:43:10, when NSX's (also known as the CINC exchange) quote stopped updating in symbols within the alphabetic range HD through ITUB. Within 2 minutes (14:45:03) the NBBOs of 48 of these stocks started to lock and cross. Off and on over the next 45 minutes, NSX sporadically updated quotes and trades and some symbols had a crossed NBBO from a stake NSX quote until 15:28:12.

The examples below provide more evidence that crossed quotes have a definite impact on trading at Dark Pools and order matching at Wholesalers (who internalize orders from E*Trade, Ameritrade and other retail brokers).


   
 
1. Herbalife (HLF) showing trades color coded by exchange and NBBO (Shaded Red if Crossed - Best Bid > Best Ask).
2. HLF showing best bids and best asks color coded by exchange.
An Ask from NSX (Cinc) at $38.75 gets stale (not updated) and causes a crossed market when other exchange bids drift higher.
3. HLF showing sub-penny trades - an indication of Wholesaler's internalizing (matching) retail orders.
When the NBBO is crossed or locked (red/yellow shading), internalizers stop matching orders.

Here is another example: Symbol IWM.

4. iShares Russell 2000 (IWM) showing trades color coded by exchange and NBBO (Shaded Red if Crossed - Best Bid > Best Ask).
5. IWM showing best bids and best asks color coded by exchange and NBBO (Shaded Red if Crossed - Best Bid > Best Ask).
6. IWM showing sub-penny trades - an indication of when wholesalers internalize (match out of inventory) retail orders.
When the NBBO is crossed or locked (red/yellow shading), internalizers stop matching orders.
7. IWM showing trades from Dark Pools and NBBO (Shaded Red if Crossed - Best Bid > Best Ask).
Dark pool trading is definitely affected when the NBBO crosses.
8. IWM showing quote spread for PACF (NY-ARCA  - red) and CINC (NSX - yellow). Cinc's quote stops updating, causing the crossed market.

Here is an example during NYSE's outage. Stock SunTrust Banks, symbol STI

9. STI showing trades color coded by exchange and NBBO (Shaded Red if Crossed - Best Bid > Best Ask).
10. STI showing best bids and best asks color coded by exchange and NBBO (Shaded Red if Crossed - Best Bid > Best Ask).
11. STI showing sub-penny trades - an indication of when wholesalers internalize (match out of inventory) retail orders.
When the NBBO is crossed or locked (red/yellow shading), internalizers stop matching orders.
12. STI showing trades from Dark Pools and NBBO (Shaded Red if Crossed - Best Bid > Best Ask).
13. STI showing NYSE trades (black circles), NYSE quote spread (blue shading) and NBBO.

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