Nanex 23-Apr-2014 ~ Jumping Apple for a Penny

Can you jump in front of the Best Bid or Offer by 1/100th of a penny?

Here's a secret. You can identify retail trades, and even whether they were from buy or sell orders. Look for trade prices with 4 decimal places. If the last 2 digits (thousandths and ten-thousandths place) are between 90 and 99, that trade was most likely from a retail buy order. If the last 2 digits are between 1 and 10, then that trade was most likely from a retail sell order. What is going on you ask? Internalizers (wholesalers) are jumping in front of the best bid or offer by a tiny amount (typically 1 penny on a 100 share order) to capture a trade that should have gone to whoever posted the limit order publicly. The internalizer will then try and make the spread - but if the market moves against them, they can quickly dump the trade on the order they jumped in front of.

Does this happen often? Yes, quite frequently. The chart below shows this jumping-in-front-of-for-a-penny behavior in Apple stock over about 1 minute of time. For the cost of a penny to jump in front of a $50,000 trade (100 shares) and try and make the spread.

Don't you wish you could do that?

See also this page showing the same thing happening in Facebook.

The image below alternates between showing trades from retail buying and retail selling. Note how retail buy market orders always execute near (but a fraction of a penny below) the top of the NBBO (top of gray shading) and retail sell market orders always execute near (but a fraction of a penny above) the bottom of the NBBO. This is where other limit orders that set the NBBO are getting front run by internalizers. For details on how this works, read sub-penny pricing which explains what "retail price improvement" is really all about.

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