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January 1, 2013

Out of Order

By Tom Steinert-Threlkeld

That exemplifies the pressure being felt by exchanges to show they are not playing favorites, when they seek rule changes when filing for approval of new order types or functions.

"We've seen in the past few weeks an increased interest among our member firms, but really also in popular culture, if you will, in exchange operation," Blaugrund said in an interview with Traders Magazine. "And I think it's our view that the more transparency around how things operate, the better."

The interactive breakout of its order types, now widely disseminated via email and on Nasdaq OMX's Web sites, means institutional investors and retail investors can see "there are no secret order types, every member has access to every order type, and that every order is going to interact based on price-time priority," Blaugrund said. "There are no orders that give anyone some sort of special advantage."


Slanting The Playing Field

But brokers and institutional traders suspect-or fear-that many of the new order types are set up largely to slant the playing field toward the trading firms with the shortest time horizons.

Enter a permutation known as the post-only order. "The ultra-high-frequency trading firms are doing everything in their power to come up with enhanced ways for them to (engage in) post-only order flow," said Sal Arnuk, co-founder of Themis Trading in Chatham, N.J., and a critic of electronic mechanisms that allow such "predators" to get their orders to the front of a queue of orders in exchanges that are almost exclusively based on giving priority to the first order to show up at a given price.

The reason: rebates. Use of a "post-only" order allows a trader to "post" an order but "only" have it come into play if there is "adequate price improvement," in BATS's terms. That means, in turn, it's able to earn a rebate for adding liquidity to the market, because it does not automatically take out a displayed order that might be resting on an electronic order book.

The post-only order is not particularly innovative, said Jamie Selway, head of liquidity management at agency broker Investment Technology Group. Plus, the focus on rebates "is not a good thing always. If you're a broker and you're concerned more about the fee you pay than best execution, that's sort of a conflict of interest."

As of Nov. 1, BATS charged 29 hundredths of a penny per share for removing liquidity from its primary exchange, known as the BZX market. Conversely, a firm got somewhere between 25 hundredths and 29 hundredths of a penny for adding liquidity.

That's "only" 29 cents on each 100 shares being traded. But if you "add" 10 million shares of liquidity, it adds up. At $29,000 a day, that would be roughly $7.25 million a year.

But the type of order that has drawn the most scrutiny in the past year is something industry consultant and former UBS managing director Haim Bodek calls a "hide and light" order.