Group Co.
A Case for Asymmetric Speed Bumps in U.S. Equities
Traders Magazine Online News, August 23, 2018
This item was originally published on www.greenwich.com on August 20, 2018.
A key driver of success in trading the modern U.S. equities markets is speed.
When all market participants have access to the same information, the winners are those who can analyze and interpret this information effectively, but also those who can implement their ideas before the market re-prices and the alpha is lost.
Every day profits are made by the fastest traders who react quickly to new information, whether it’s an earnings release, economic data, geopolitical news, or a price movement in a related instrument trading in a geographically dispersed data center.
For some latency arbitrage trading firms, speed is so important that they will invest significant sums in technology such as dedicated microwave links, laser technology or in some cases shortwave radio, in order to achieve speed advantages of mere thousandths to millionths of a second.
One common strategy, for example, is a proprietary trading firm reacting to a tick in the futures market in Chicago and racing data across the country to pick off the now stale liquidity provider quotes in related instruments trading on exchanges with data centers are in New Jersey.
There is a strong argument that this type of trading activity places a material tax on the industry, in the form of wider spreads and, therefore, worse execution prices as liquidity providers seek to avoid being adversely selected by firms deploying these latency arbitrage strategies.
Over the past two years, exchanges have innovated in ways designed to ameliorate the effects of some of these strategies. Most notably, IEX, which launched its stock exchange two years ago, employs a symmetrical speed bump that delays both incoming liquidity providing orders and incoming liquidity removing orders by 350 microseconds to reduce the importance of speed in the trading equation.
Although the speed bump was controversial at the time its exchange application was filed, it had garnered strong support among the institutional investing community. In our 2017 Market Structure & Trading Technology study, we found that 85% of buy-side traders were supportive of the IEX speed bump or other exchange speed bumps.
In February of this year, Edwin Hu, an SEC economist, published a quantitative study of executions on the IEX exchange[1]. The study found that market quality, as measured by quoted, effective and realized spreads, actually improved when symbols began trading on IEX.
Asymmetrical Speed Bump
While the speed bump pioneered by IEX is ostensibly symmetrical (meaning all orders are subject to the same time delay), some have argued that in reality this is not the case.
This is because non-displayed orders that make up the bulk of IEX’s executed liquidity[2] are automatically repriced (using the DPEG crumbling quote algorithm) without having to pass through the speed bump. This means these orders are able to get out of the way of incoming liquidity taking orders, which is a form of an asymmetrical speed bump.
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