There are usually two sides to an argument – and the recently announced tick pilot program by the Securities and Exchange Commission is no exception. Now, a prop shop is weighing in after several exchanges and agency brokers have.
Bright Trading, a proprietary trading firm headquartered in Las Vegas, contacted Traders to voice its opinion on the tick pilot program and some of the comments made about it. Specifically, Dennis Dick, a senior trader at the firm, told Traders that he and his firm feel that small cap stocks do suffer in part to dark pool trading.
This comes on the heels of agency-only and technology company ITG’s recent comments about the pilot program. At issue, Dick said, were ITG’s belief that dark pools and the trading that goes on in them doesn’t affect small cap stocks’ trading.
“Safe to say, we firmly disagree with ITG that there is no linkage between poor market quality in small caps and high levels of dark liquidity,” Dick said.
The “trade-at” rule has long been sought after by public exchanges as a way to win back market share against off-exchange competitors such as dark pools or other alternative trading systems. Currently, about 40 percent of all U.S. stocks trade in dark pools and other non-public venues. The exchanges who have lost market share to the dark pools over the last several years, want to grab some of this order flow back.
See:ITG Says Tick Pilot OK, But Without Trade-At Proviso
In an interview with Traders on Tuesday about the small tick pilot program, ITG’s head of electronic brokerage Jamie Selway said that the small tick pilot should not include the so-called ‘trade-at’ provision.
“At end of day, trade-at doesn’t have that much to do with small cap stocks,” Selwway told Traders. “We see no linkage between poor market quality in small cap stocks and high levels of dark liquidity or internalization. Trade-at, in our opinion, would be more of a large cap story and this pilot is about small cap liquidity and its provision.”
Currently, SEC rules require trades to be executed at the best available bid or offer, whether it be on a public exchange or in a dark pool or other unlit venue. Dark pools don’t publicly disclose bids or offers.
ITG operates the POSIT dark pool in the U.S. It also operates dark pools in 33 other countries globally.
Bright Trading also said that the lack of trading interest in the small and mid-cap companies is due primarily to a lack of liquidity caused by the discouragement of limit order traders. It cited two main reasons for this phenomenon; algorithmic penny jumping and broker-dealer Internalization and payment for order flow (PFOF.)
In describing algorithmic penny-jumping, Dick writes that many small-caps trade with very wide spreads, which should be attractive for market makers to trade because of the potential profit opportunity from the wide spread. However, algorithmic penny-jumping programs appear to dominate these securities discouraging other participants from providing liquidity.
On the issue of broker dealer internalization, PFOF and dark pools, Bright Trading said the biggest issue that its traders cite is their inability to get filled on their limit orders, even when they are at the top of the order queue. This is primarily caused due to over the counter (OTC) market makers intercepting marketable order flow that would otherwise interact with the trader’s displayed limit order.
“In our comment letter to the Commission back in June of 2010, we cited this issue and recommended that the Commission require an OTC market maker internalizing a retail order to provide “meaningful” price improvement over the displayed quote,” Dick wrote. “We commend the Commission in attempting to address this issue by including a trade-at prohibition in Test Group 3 of the tick size pilot.”
Bright Trading’s full comment letter to the SEC is HERE
