As the lifetime of a quote approaches zero, the arguments for and against a minimum-quote-life
rule become more and more interesting. Let’s suppose, for example, that the
day has arrived where a few of the top HFT systems are able to send and cancel quotes
in 1 nanosecond [ns] (light travels 30cm or about 1 foot in 1 ns). At this rate, we
might occasionally see 1 billion quotes per second
per stock (qpss)
OK, that was an extreme example, so let’s slow it down by a factor of 1,000 — replace
nanosecond (ns) with microsecond (us). Now we could expect a peak rate of 1 million
qpss. Still extreme? Let's go down another factor of 1,000 — replace
microsecond (us) with millisecond (ms). Now we could expect a peak rate of 1,000 qpss — we surpassed this rate in 2009 and are speeding towards microseconds.
Perhaps the definition of a quote is what needs to be modernized, or maybe we need
a new name for what used to be called a quote. Not long ago, when a trader
(or their
auto-trading software) received a quote marked auto-execute, there
was a reasonable
expectation of hitting that quote — the only real exception being that another trader
might beat them to it. Today, under the same circumstances, the same auto-execute
quote would almost certainly have expired or been replaced many times during the same
time period.
The change in semantics becomes most important when we look at the definition of the
NBBO (National Best Bid/Offer). Per Reg NMS, the NBBO is defined to mean the best
bid/offer received by the security information processor (CQS, UQDF). But no one,
uses CQS or UQDF for that anymore.
So what do they use?
Each exchange computes the NBBO internally from their direct connections to other
exchanges. As the speed of trading increases, the likelihood of two exchanges having
the same NBBO decreases. Most of this is because of the pesky speed-of-light limitation.
So how does a trader know whether a trade was routed properly to the exchange with
the best price?
He doesn't. It is impossible.
You see, each exchange’s view of the
other exchange prices only exists in memory on
that exchange's machines. It is not
recorded. There is no audit trail. Sure, each exchange provides book-level data, but
that only includes prices for that one exchange
— not the prices that existed on the other
exchanges at the time of each order.
If we are going to allow machines to trade faster and faster, then at the very minimum,
there must be an audit trail data that includes each exchange’s view of top-of-book
quotes for every linked exchange trading that stock. In other words, what now only exists in an exchange routing computer’s
RAM, needs to be captured and made available. The exchange routing simulation video below may help to visualize this. In the video,
each box represents one exchange and its routing table to the other exchanges -- that
is the information which needs to be recorded to assure trade through price protection.
Essentially, each interlinked exchange would end up recording its view of every exchanges'
top-of-the-book prices -- exactly what CQS (the box at the bottom) does now.
So why not use just use CQS? Auditing, maintaining, and improving one system is much
better
than 14 (one for each exchange). Well, because, as some more informed people
have told us (including the SEC), CQS is not as fast because it has to aggregate information
from the other exchanges.
Wait a minute.
How can an exchange insure every order receives the best prices, if it doesn't aggregate
information from all the other exchanges? Take a close look at the simulation video
and note that every exchange must essentially replicate CQS's aggregation function.
There is no way around this.
There is more.
CQS's aggregation policy should be something that is easy to verify. How about the
14 other aggregation policies used by the 14 other exchanges?
We understand how difficult it can be to grasp these problems. Understanding system
behaviour when the speed-of-light is the dominant source of latency is hard. When
the fate of your nation's financial infrastructure is at stake, we think you better
have solid answers to these questions.
Finally, we just like to point out, that last year, 2.5 million
subscribers spent $450+ million in exchange subscription fees
to receive and process CQS.
Exchange Routing
The video shows how orders flow between linked exchanges trading one stock. Orders
are represented by triangles, and begin from the edge of the display and feed into one exchange. That exchange then updates and checks it internal table to determine
whether to route the order to another exchange with a better price, execute it locally,
or simply update the top of the book for that exchange. Only orders that affect the
top of the exchange book are included to reduce clutter. The order is then transmitted
to every other exchange making a market in the stock (via premium direct exchange
feeds) as well as CQS which is shown at the bottom. When other exchanges receive the
order, they update their internal tables in order to keep track of the other exchanges'
top-of-the-book quotes.
The price data within each box therefore represents how that exchange views the prices
on other exchanges trading that stock. Unlike this simulation which assumes a perfect
world: due to the variations in distance and connection
quality, system load, and
other real-world imperfections, exchanges won't always have identical NBBO information.
As update rates increase, the percentage of time that
all exchanges have identical NBBO information will rapidly drop to zero.
Download the exchange routing simulation application.
Simply unzip to an empty directory, and drag-and-drop one of the text files over the
executable.
This report and all material shown on this
website is published by Nanex, LLC and may not be reproduced, disseminated, or
distributed, in part or in whole, by any means, outside of the recipient's
organization without express written authorization from Nanex. It is a
violation of federal copyright law to reproduce all or part of this publication
or its contents by any means. This material does not constitute a solicitation
for the purchase or sale of any securities or investments. The opinions
expressed herein are based on publicly available information and are considered
reliable. However, Nanex makes NO WARRANTIES OR REPRESENTATIONS OF ANY SORT
with respect to this report. Any person using this material does so solely at
their own risk and Nanex and/or its employees shall be under no liability
whatsoever in any respect thereof.
