Nanex Research

Nanex ~ 31-Jul-2014 ~ Retail Trades Disadvantaged by Direct Feeds

Internalizers buy at the direct feed price, sell to retail at the SIP feed price

Executive Summary

While internalizers matching retail trades claim they use direct feeds for pricing, there is overwhelming evidence that retail customers, in fact, are getting prices based on the SIP (Securities Information Processor also known as the consolidated quote). It may be that internalizers making this claim mean that they are using direct feed pricing for themselves to buy and sell stock on exchanges, but they give customers prices based on the SIP. Perhaps the question to ask the internalizers paying for retail customer order flow: what prices are you assigning to retail customer trades?

The Setting

During the first 30 minutes of the August 22, 2013 Nasdaq black out, a curious thing happened. SIP quotes stopped updating, but trades continued to print in stocks for at least another 30 minutes, and in stocks that had price movement, two clear price bands formed: one band contained trades priced at the last known (and very stale) NBBO (National Best Bid/Offer) sent by the SIP, while the other band contained trades priced on direct feeds that High Frequency Traders (HFT) pay exchanges princely sums for. Exchanges can legally sell direct feeds, as long as they make trade and quote information available to the SIP first or at the same time as direct feeds. With the SIP no longer transmitting quotes, yet trading seemingly unaffected, it's probably a good bet that the exchanges weren't providing the SIP with trade and quote information at the same time as the direct feeds. While that is clearly illegal, it's something we have already covered in detail.

The Evidence

This paper is about understanding which trades executed based on direct feed prices and which trades executed based on the stale SIP price. While we only show prices for the stock of Apple (symbol AAPL), many, if not all of Nasdaq stocks during the same time present the same evidence. Furthermore, we have seen this phenomenon during other times (e.g. September 4, 2013, and June 2, 2014) when the SIP had problems, but direct feeds did not.

Note, there are 4 main sources of trades reported to TRFs (Trade Reporting Facility, which handle trade reporting for unlit markets):

  1. Retail trades, sent by internalizers, also called wholesalers. Internalizers pay brokers a fee for the privilege of matching retail orders. The claim they provide price improvement.
  2. Alternative Trading Systems (ATS), sometimes called Dark Pools. Some ATS's (Lavaflow) publish quotes to FINRA's ADF, but this distinction is unnecessary for this paper.
  3. "Upstairs trading", or off-exchange negotiated transactions outside of a broker dark pool, (High Touch).
  4. Broker internalization engines that are not registered as an ATS.

This paper focuses on retail trades executed (matched) by internalizers.

1. The SIP stops sending the NBBO in Apple stock at 12:04:40.

2. A plot of the trade prices reveals two distinct bands.

3. Trades from unlit markets show the same two price bands.

4. Retail trades execute at the last NBBO price sent by the SIP, exclusively, for 28 minutes.

To understand how we can identify retail trades, read this page (keep following links if necessary, as this rabbit hole is deep).


The evidence clearly shows that retail orders are getting prices based on the SIP, even after the SIP stops updating for 28 minutes. Watch this short clip which shows an internalizer telling congressmen that they use direct feeds. Maybe the congressmen should ask - "you use direct feeds for your benefit, but what feed do you use to assign prices to the retail customer"?.

Nanex Research