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HaimBodek'sPresentationToTradeTechOnHFTAndHis
ControversialFindings
Weblogpost.Phil'sStockWorld[Phil'sStockWorldBLOG],Newstex.Jun14,2013.

Abstract
Noneavailable.
CourtesyofZeroHedge.Vieworiginalposthere.
SubmittedbyCalibratedConfidence.
HFTandRule610,herewego.AtTradeTechthisyear,HaimBodekofDecimusCapitalsharedhispresentationonReg
NMSandhownewregulationsaregoingtochangeeverythingabouthighfrequencytrading.ZeroHedgehasastash
coverageofonDarkPoolsandthestoryHaimhasfromjustatypicalautomatedtradertoamarketstructurereform
activist.ForthosefamiliarwiththedepthsofZH,youmayunderstandmostofwhatispresented,thoughwatching
theentire43+minutepresentationishighlysuggested.Forthoselookingforcompactvideo'sonHFTalsofromHaim,
seehere,orgetabooktoread.
Iwon'teventrytoaddanylongwindedparagraphs.Justwatchthis.Andonethingofnoteisat25:45,the"speed"
wekeephearingaboutonthetheuniformedmainstreamandslideshowwebsites,isn'ttheproblem,it'swhoissmart
enoughtoknowwhatordertypetosendandwhentosendit.FullTranscriptbelowvideo.Hopeyouallenjoythe
weekend.
FromTradeTechWest:
Transcript:
So,tostartoutwith,IthinkI'lljusttellyouwhatIamhitting.IamhittingthebasicHighFrequencyTradingstrategy
that'sbeendominantinU.S.equitiessinceaninflectionpointstartinginearly,orinlate2006,early2007.ThenIam
goingtoexplainhowHFTinU.S.equitiesandregulationNMSareintimatelyintertwined.Iamgoingtoexplainsome
ofthepropertiesofHFTorientedspecialordertypesthatgiveHFTsanadvantageoverinstitutions.Iamgoingtohit
onsomeofthelandminesthatyoucanencounterwithinordermatchingengines,andthenIamgoingtogivea
forecaston,atleastfrommyperspective,what'sgoingtohappenoverthecourseof2013becausemostofthingsI
amdiscussingherearehugetopicsintheindustryandarealsoundergoingsignificantregulatoryscrutiny.
So,scalpingstrategies,primaryfeatures,andyouneedtounderstandthesefeaturesgenerallysoyoucanunderstand
howtheordertypesREGandNMSandeverythingelseplaysintothem.Thereisaconnectionbetweenthefeatures
ofthisclassofAlgorithmTradingStrategyandwhattheexchangeshavedoneintermsofevolutionofmarket
structure.Thebasicpropertyishighfrequencyturnover,thisinearly2000s,ifyoutoldmethatIcouldgetinandout
ofatradein10secondsandIcouldget5%ofaname,Iwouldthinkyouwerecrazy,butthat'sthegoalofthistype
ofstrategy.ThefundamentalpropertythatIthinkmostofthequantitativepropertytradingfirmsoutsideofHFT
missedisthecriticalimportanceofqueuepositionwithinyourstrategyitself,andIamgoingtoexplainthatprobably
alittlebitmoredetailinacoupleslideshere.
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Ofcourse,mostlowlatency/highfrequencyorientedstrategiesaregoingtohavepreciseandtimelyreactionsto
changingmarketmicrostructureevents.Wealsohavethisclassofstrategy,especiallymaybe20042005starts
leveragingspecialordertypesandordermatchingenginefeatures,soyoustartseeinginnovationsinthemid2000s
thatgetsmoreandmorecomplex,andmanyofthosefeatureswerebasicallyevolvedtoaccommodatetheneedsof
highfrequencytraders,specificfirmsinfact.Thistypeofstrategycompressesquitequickly,sothesubsidyofrebateis
kindofcriticaltothisclassofstrategy,andwehavepostonlyorderswhichcontroltherebatecostsandmakesure
youaren'texposedtotakerfees,andthenthelastthingIthinkisveryimportanttounderstandisthatthesefirmsin
thisclassofstrategyconsiderhighfrequencyturnover,andexitingriskisbasicallyaninsuranceagainstadverse
selectionandtoxicorderflow,sotheideaisthattheycan'tforecastwhat'sgoingtohappeninthefuture,andUSLit
marketsarequitetoxic,Theyaregoingtorapidlytrytogetoutofallofinventory,andthat's,youhearofthesefirms
thattrade10%ofthemarketandtheyareflatendofday,that'sconnectedtothatconcept.Andsoit'savery
importantconceptbecausewhenyouhavehalfoftheUSMarkethaveextremelylowrisktolerance,youget
derivativeeffectsinthemarketitself,suchastheminiflashcrash.I'llexplainhowthathappens.
Next,thesearejustgeneralbulletpointsonthestrategy.Yourequirepricetimeprioritymarketstructuretoexploit
thequeueposition,sotheseguyshavetobefastbecausetheyarejusttryingtogettothetopoftheorderbook.
What'simportanttounderstandisthereareonlycertainmomentsintimewhenyoucangettothetopoftheorder
book,whichiswhyspeedmatters,andprecisionmatters.Thesestrategiesarenotjoiningabetterofferandslowly
risingupthequeue.Theyaretryingtosetthemarketandgettothetopfirst,andthatcanonlybedone,it'sso
precise,it'srepeatedlymicroseconds.So,lowlatencyisqueueforsuperiorqueueposition.Youget5or6firmsinthe
marketthathavethisclassofalgorithm,itcompressesquiterapidlydowntoaneffectivezerowidthmarket.What
doesthatmeaninpractice?Itmeansyoubuyatthebid,youarenottryingtoscalpoutforapenny,youaretryingto
exitatthatbidprice,andthat's...youkindofthinkofthatasyourbestcasescenario.Andthatwouldmakealotof
senseifyouthinkabouttheexhaustflowandtheinstitutionalorderflowthat'sconstantlyhittingtheU.S.market,
andtryingtoaccessliquidity,sothisisbasicallyaflipoutstrategy,andifgoyoulookthroughthedata,especiallyafter
youlearnsomeoftheseconcepts,youcaneasilyseeintickdata,prettymucheverythingIamtalkingaboutthere,
butyoukindofneedaframeworktounderstandwhyit'shappening,andthat'swhatIamtryingtoexplain.
So,let'stalkaboutqueueposition,thisiscompletelynave,dumbexplanation,butIthinkit'scompelling.Let'ssayI
haveanavestrategy,Ihavenoviewofthefuture,Iaminamarketthat'sbasicallynormaldistributionofevents
withacompletelyneutral,randomorderflow,ifIgettothetopofthequeue,andHFT'scaremostlyaboutaonetick
winnerorloser.Theviewofwhat'sgoingtohappenbeyondthatislessimportantthantheconceptthatifImakea
pennyorImakeaonetickwinnermarkettomarket,Icangetout,andIcanlockinaprofit.Sothat'skindofthe
keyidea,thewholespaceofthefuturecompressesintouptick,downtick.IfIamatthetopofthequeue,Iam
likelytotrademostofmyonetickwinners,ifIamtopofthequeue,it'sunlikelythatthenexttickisgoingtoclear
out,let'ssayIamonthebid,isgoingtoclearouttheentireofferandmoveawayfromme.SoIamgoingtogetto
tradeasignificantportionofmyonetickwinnersifIamattopofqueue.
Let'ssayIamrestingthere,keepinmindIamalsogoingtotradeallofmyoneticklosers,right?Thisisrandom.
Thisisnothingaboutinformation,right?Iamresting,marketgoesagainstme,Itradeeverything.Marketgoesthe
otherwayItradesomeofthegoodtrades,okay?That'skindofanexplanationonwhyspreadandrebatesubsidyis
soimportant,becauseanavejoiningalgorithmisexpectedloss,inlet'ssayaveryverysmallticksize.Rebateand
ticksizewillbasicallymakeanavestrategyprofitable.However,youknow,thiswouldonlyworkiftherewasonlyone
firmdoingit,soI'llexplainlaterinthepresentationwhathappens,howdoesthisworkwhentherearesixfirmsandI
willexplainlater,buttheothersituation,andthinkaboutaprogramtradingdesk,that'spassivelyorelectronictrading
deskiswhatwearecallingthemnow,passivelyjoiningoffers,Theyareatthebackofthequeue.What'sgoingto
happen,theyareunlikelytotrade,especiallyinanamelikeBAC,wheretheyarewayatthebottom,Ithinkthey
have70,000sharesaheadofthem.Theyareunlikelytotradeanyonetickwinners,andtheytradeallonetick
losers.So,ifyou'reatthebottomofthequeue,youhemorrhage.Youbleedtodeathveryquickly.Okay?
Theotherthing,whichIwill...nowthatIexplainedthatit'sallaboutshiftingthedistributionoftradeevents,when
thattoxictradecomesinthat'sgoingtosweepagainstme,thereisanotherconceptembeddedinthis,totryto
detectwhenthat'shappeningandtocancel.Youknow,youheareverythingaboutHFTiscancelingallthetime,
cancelationisextremelyimportant.Thereisjustanopportunitycost.IfIgetout,Icanaffordtocancel2030times,
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togetoutofthewaythatbiglandminecomingin,Ihavealotoffalsepositives,lotoffalsealerts,thenIcangetout
oftheway,anditonlycostmemarketshare.Sothereisanemphasisonavoidingnegativealpha,andbyavoiding,
that'skindofamarketmakingmindset.IfIavoidthattoxicflowcomingin,mydistributionisgoingtobiastowards
positivemeanintermsofmyPNL.Sothisconceptofsweeprisk,wherealargeorder,that's...you,guys'maybe,
comesinandtakesoutthewholepricepointthatisbaneofthiswholestrategy.Thatstrategywilllosemoneyon
thattradeifittradesagainstit.Whatisgoingtohappen,usually,iswhenasweepisdetectedyoutrytocancel,as
it'ssweepingthemarket.Let'ssayIamononemarket,Igethitthere,Igetofftheothermarket,that'swhyyou
seearapidwithdrawalliquidity,andwhatIamgoingtotrytodoiseitherhitsomedummybehindme,let'ssayI
traded,Iamgoingtohitthedummybehindme,andthinkaboutaninvertedmarketlike,youknow,likewhat'sit
Ajay,right?IcanhitadummybehindmewhoispostingonAjay,exitthatbadtrade,whichIgotrebatefor,andI
actuallymakeanetprofitonmybadtradesifImanagesweepriskcorrectly,butwhatthatdoes,sinceeverybody
doesitintheHFTspace,youknow,thetopfivesixfirmsareallrespondingtotheexactconditions,Theyare
respondingtoeachother,I'llgiveyouaveryclearthing.Ifsomeone'satthetopofthequeueandthat'sfastguy,and
heisalwaysatthetopofthequeue,andhecancels,welltheycanseethatoverthepricefeed,andtheyarelike
"Whoa,Iamgoingtogetoutoftheway,something'scomingin"sothereisthisconceptoflookingattheelectronic
crowdandtryingtoforecastthatasweepriskiscomingin.Runaway,andthat,iftherearenootheralgorithmic
tradingtraditionsinsizeinthatname,thatwillcauseacascadeeffect,andinsomecases,you'llgettheminiflash
crashwhenthereisbasicallynoalgorithmicstrategyintherethatcancorrectpricesthatarechargeablefromkindof
sayastatisticalstandpoint.Soifthereisn'tastattodiveintheretotradethatbadprice,youaregoingtogetamini
crashes,acrashiswhen67participantsimmediatelyflipoutofthemarket.
AsIsaid,gobackandlookatyourtickdataandBAC,you'llseethisishowthenametrades.Solet'stalkabout
regulationNMS,thisformulatedin2005,establishedin2007,aseriesofinitiativesdesignedtomodernizeand
strengthenthenationalmarketsystemforequitiessecurities.ThetermHFTwasnotwidelyuseduntilREGNMS
cameoutandspecificfirmshadenormouschangeintheirprofitability.Forme,everyone'slike"What'sHFT?"Tome,
HFT,inU.S.Equitiesisaclassofstrategiesrunbyaround10firmsthatnooneheardofpriorto2007andtheywere
basicallythemarketleadersafter2007.Ifyouweremakingalotofmoneyintheearly2000s,andtherearesome
firmsthatouttherehavehighfrequencytradingdesks,it'snotthesametypeofhighfrequencytradingthatis
dominatingU.S.Equityvolumesrightnow.So,theimportantthingtounderstandistheadoptionofREGNMS
coincideswithaperiodofintenseHFTvolumegrowth.So,thinkaboutwhat'sgoingonasREGNMSisbeing
negotiatedandrolledoutfrom2005to2007.HFTsarestartingtogetmorevolume,theygotsomespecialorder
types,theyaremaking$20millionnetayear,andthebanksarestillignoringthembecausethat'snotaninteresting
enoughnumber,right?Butthislegislation,thisregulation'scominginandit'sgoingtochangethewholegame.Every
singleaspectofpricemovement,whatispermissible,whatisnotpermissible,whattradescanhappen,andalsothe
momentsintimewhenIcangettothetopofthequeue,andwhatcase...whatmightimpactmightbeofcancelling
orders,allofthatiseffectedbyREGNMS,thewholegamechanges.SothisiskindofacrisispointforHFT,and
certainindividualsorfirmswereveryinvolvedintryingtoassertorproactivelyargueforcertainfeatureswithinREG
NMS.Asyoucansee,thesearethebulletpoints:*Gettingtothetop*Cancellingaheadofsweeps.*Who'sthe
maker,who'sthetaker?*WhatsignalscanIgetoverthepricefeedtodetectadversefills?*Andtheaspectofwhat
speedadvantages,wheredoesspeedhelpmeandwheredoesitnot?Iwantmicrostructureconditions.Allofitis
impactedbyREGNMS.
Iamgoingtogiveyoutwoveryspecificexamples:Rule610ofREGNMSbannedblackmarkets.Atradingcentermust
prohibititsmembersfromengaginginapatternorpracticeofdisplayingquotationsthatlockorcrossanyprotective
quotationinanNMSstock.Whatdoesthatmean?Thereisatwotickwidemarket,Icouldjumpinthemiddleandbe
thebestbidoroffer,butIwouldlikelylock,youknow,havemypricebethesamepriceasanopposingbidorofferon
ananothermarket.Well,that'sinadmissibleaccordingtoREGNMS.Itwasacriticalconstraint,thatonepiecethere,
Rule610completelychangestheTopofQueuegame,soit'sacriticalconstraintonTopofQueuestrategies,now
whatareexchangesdoinginthatsituation?Theyareactivelychangingyourpriceandrebookingyou,andI'lltalk
aboutthatlater.Theyarenotallowedtoacceptyourorderintoalock,soinotherwords,thelegislationsaysyouare
notallowedtosendthatorderandgettothetopofthequeueinpreciselytheconditionswhereanHFTwouldwant
todothat.Right?Sojustremember,thebasicdefaultbehavioroftheseexchangesistonotletyoupostthe
aggressiveprice.Theywillchangepriceonyou,andsomeexchanges,whichIthinkiskindofcomical,willactually
requirethatyoucalluptheHelpdeskandaskforaportsettingchange,sothatyourconfirmationscomingback
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actuallyindicatethatyourpricewaschanged,soyoucan'tevenlookatyourfillsandknowwhetherornot,sorry,
yourconfirmationsandknowwhetherornotyourorderwasadjustedtocomplywithRule610unlessyoucallthis
particularexchangeandhavethemlikechangesomedatabasecodes,sothis,alotofpeoplewilllookatdataandsay
"Itlooksokaytome"andIsay"Well,that'sactuallynotcorrectdata,right?"Youneedtoknowexactlyeverysingle
exchangeintheU.S.hassomevariantofthesepractices,soifyou'renotontopofthevariousspecificfeaturesof
eachone,thenyourorderisbasicallybeingtreatedtosomekindofdefaultbehavior,andIwouldarguethatsome
exchanges,theDefaultistolerable,andinothers,it'scompletelyegregiouswhathappenstoyourorder.That'soneof
thereasonsIbecameamarketreformadvocate.
Rule611mandatedtradethroughprotections.Atradecentermustventtradethroughofprotectedquotationsand
NMSstock.Well,thatalsocreatesanimportantconstraint.Ittellsyouwhatpricesareallowedtotradeornot.What
doesthatmeaninpractice?Idon'tknow,forIOCsthataremarketableinfastmarketconditions,3040%incertain
namesmightberejected.Youarenotgettingrejectedbecauseoftheliquiditywasn'tthere,youaregettingrejected
becauseyouviolatedrule611,youjusthavetolookatthecodeonyourreject,andyourealizeyouweretryingtohit
thatorder,itwasthere,youmisseditbecauseofrule611,well,guesswhathappens?IfthereisaslowSIPfeed,
think...theregulatoryfeed,thinkwhatNYSEjustgotfinedfor.Ifthereisjustoneexchangethatisslowinpumping
baddatatothatSIP,what'sgoingtohappenisyouarenotgoingtobeabletotradepricesthatshouldbetradeable,
rightandyouaregoingtogetimmenseadverseselection.Wellguesswhat?ModernHFThasgottenaroundallof
theseinconveniencesofREGNMS,right.Sothat'sthestory,isthatREGNMScompletelyscrewedupthegame,and
theyfoundcleverwaysintheexchangescreatedinnovationstobasicallycircumventtheentireregulatoryframework
inalloftheareasthatimpactedHFTneeds.Allright,sowhathappensafter2007?Well,theexchangesgoona
completeinnovationbinge,theycreateanumberofspecialordertypes,youknow,thepresssays2000,nothereis
like15ordertypesthatmatter.The2000ordertypes,thewayIthinkaboutit,isthat'stheforest.Youhavetoknow
whattreesyou'regoingaftertobasicallyprotectyourselfortakeadvantageofthefeaturesIamexplaining.Thereis
alsoordermodifiers,reallyquiteinterestingfieldsthatyoucansetonyourordersthatbasicallydictateveryprecise
orderhandlingtreatmentduringlockedmarketsforexample.Andthenlastly,newportsettings.Thatmeansyou
havetocalluptheexchange,andknowthatthereisadatabasecodethatifIsetitthisway,Igettotreatedtheway
anHFTwouldprefer.Again,allthisstuffisnotthedefaultorderhandlingoftheU.S.Equitymarkets.
SowhatIamarguinghereandhereisthetruth,withoutthesefeatures,HFTgoesbackto20052006,andlookslike
acuriosityagain,right.Thisarethefeaturesthatsuperchargestheentireindustry.The'secretsauce'ofHFTsoften
amountstolittlemorethantheapplicationoftheseinnovationsintheirintendedusagescenarios,sothat'smybeef,
right.It'sveryclearonceyouareaninsiderwhatthepurposeandintentandintendedusagescenariosareofthese
features,theyareallconnectedtoprecisemicrosecondevents,right?Theordertype,ifyoujustuseitrandomly
doesn'tdoanythingforyou.Youhavetoactuallyuseitinthemomentsthatmatterandthatisnotproperlydisclosed
byexchanges,butoverthelast18months,therehasbeensignificantchangebecausethefactthatthesefeatures
werenotdisclosedadequatelyandtheusagescenariosofthosefeaturesissomethingthatregulatorshavebeen
lookingatfor18monthsnow.
Okay,specialordertypes,let'stalkaboutsome.Thereisactuallyaton,butwearegoingtotalkaboutjustsomeof
thecasesherethatmightbemoreeasytounderstandisprobablythebestreasonIampickingthese.Okay,on
lockedandcrossedmarket,exchangesemployanumberofpriceslidingbehaviorstocomplywiththeprohibition
againstlockedmarkets.Firstyougottounderstandwhatpriceslidingis,Ihintedatitearlier,priceslidingisan
exchangeisallowedtochange,theywouldarguethatyoumadethedecisionbecauseyouusedthatordertypewhich
isthatpriceslidingtreatment,orjustnomatterhowyoulookatit,theexchangeisadjustingyourpricebasedon
logicthattheyarerunning,andshiftingyourorderaroundintheorderbook.Rebookingyoubasically,that'swhat
priceslidingis.Andtheyaredoingthatwhen?Whenthepriceismoving.Whenyouarelockingawaymarket,when
thereisamomentwhereyoucouldgettothetopofthequeue.Basically,inthemostadvantagesituationswhere
youcangetanedgeoverthemarket,that'swhentheexchangeischangingyourprice,andthroughthisprocessof
rebooking,theyarealsochangingthetimeyouexecute.
Sothewaythatoneexchangeexplaineditisthattheyhavetheflexibilityinthesensibleandconvenientbookingof
orders,sotheyaredoingyouafavor.Theirotherchoiceistokickyourorderback.Well,guesswhat,that'sanHFT
mode.Don'thandlemyorderlikethat,kickmeback.Youcanactuallychoosethatasaportsettingononeexchange,
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okay,sothat'showit'sdescribedindocumentationinoneexchange.Thethingtorealizeaboutpriceslidingisit
occursinthistwotickmarketconditionthatIexplained,whichis,andwhatIsayhereis"Notethatallexchanges,
accordingtoREGNMS,intheory,mustdisplayatwotickorgreatergapbeforeaonetickpricemoveandNBBOis
permissible."
Sopeopleaskme,"Howfrequentisthis?"IamlikethisishoweverypricetickintheU.S.Equitymarketoperates.
Thisisthemechanics,thequantummechanicsofpricemovement,thisishappeningfor,thatiswhyHFToriented
scalpingmethodsthatusethesefeaturesare,inmyestimateistrueHFT,probably...Idon'tevenknownowbecause
it'sbeenonthewane,butatpeak,Iamthinkinglike40%ismypersonalestimateofwhatthatvolumewas,butyou
know,thatvolumeiscomingin,tothese2tickwidemarkets,exploitingordermatchingenginepracticeslikeprice
sliding,andspecialordertypestoachievecertaingoals,suchasasuperiorqueueposition.So,thepointhere,atthe
bottom,isthatHFTsarenotwaitingforthat2tickwidemarketacrosseveryexchange.Theyarenotwaitingofthose
13exchangestofadebeforetheyplacetheirbets.Allofthespecialordertypesinaclassrelatedtorule610areall
orientedtoplacingyourbetsbeforethepricemovechanges.
Okay,sopriceslidingisakeyelementinexchangeorderhandlingthatgovernswhatwecalllightinganewNBBO
price.Okay?That'sthemomentintimewhenanewpriceispermittedtochangetheregulatoryNBBO.Pricesliding
impactsthatsignificantly.Italsodetermineswhichordersareplacedinfavorableorunfavorablequeuepositions.It
determineswhenandwhatpriceordersarebookedat,anditthusdefineseligibilityformakerrebatesandtakerfees.
That'sthethingIthinkisstilllostonpeopleisthatthesepracticesareintimatelyconnectedtowhogetstherebate,
andIthinkpeoplegenerallyunderstandthattheHFTsaretryingtogetthatrebate,andthereisareasonforthat,
okay?
SoIwillprobablymake...Ijustwanttomakeonemorepointthere,theconditionsinwhichHFTsaretargetingto
makerebatesarealsofavorabletrades.Theydon'twanttogetarebateandthenhavea1tickloser,soit'sactuallya
positivealphainthoseconditions.It'snotjustaboutthefeeit'saboutdoingtherighttrade.So,pricesliding
effectivelypickswinnersandlosersinthecontextofHFTscalpingstrategies.Youcouldarguealldaylong"Well,Ididit
atthisprice,andthepricefiveminuteslater,itwasn'treallyawinnerunderthatfiveminutemark.Iamexplaining
thatit'sallaboutwhetherornotyoucouldhavegottenabetterpriceinthatveryshortinterval.AndIwouldargue
thatifyouuseHFTorientedfeatures,youwillgetabetterprice.
So,again,Iwanttoharponthis,forfiveyearsIhadtolistentothiswholenarrativeabouteverythingbeingfast,my
storyis,Iwasledtobelieveitwasaspeedissue,andIspentaboutayearbuildingoutsix________[00:25:54]and
forcingmyteamtogetfasterandfasterandfaster,whatIdidn'trealizeisbynotleveragingthespecialordertype
featuresandknowingaboutthe,whatIwouldarguewouldbeundocumentedpriceslidingpractices,bynotknowing
that,Iendedupjumpingintothesebad,disadvantagedsituationsmorefrequently,sothat's...basicallythereis...in
thisdarkholeisthestoryofmehuntingforthisbug,wellIwasbasicallybuildingasystemthatwouldjumpintowhat
Iwouldargueareordermatchingengineabuses.AndIwasbecomingthefirstdummytogetinthereandbleed,I
wasaheadofeveryone.Soit'skindofreallyquiteparadoxicalexperience,Iamgettingfasterandfasterandfaster
andthisthingishemorrhagingnow,andtherewasamomentintimewheremypartnerwasjustyellingatme,"How
canyoulose..."wearetryingtodo15,000sharesinSPY,"Howcanyoulose2penniesinSPY?It'sapennywide!"
Priceslidingandqueuejumping,andthesefeatureshavecomeupintheWallStreetJournalandIamexplaining
now.Butthat'swhatwashappening,andthestoryisIwasfinallyintroducedtothefeaturesbyoneexchange,so
thenasIwentthroughtheprocess,Ilearnedthatbasicallyallexchangeshadinsomemannerhadtoaddressthese
issuestoattractHFTorderflow.
So,thelastthingis,speedmatters,butdon'tputyourmoneyintospeed.Itmattersonlyifyouknowwhatorder
typestosendandwhentosendit,becauselowlatencytradingonlymatterstothedegreetradersactuponthesame
events.Ifyouarenotcompetingagainstsomeoneelse,iftheyarenotpullingyourquotewhileyouaretryingtohit
them,oryouaretwoguystryingtogoforthesamequeueposition,youhavegot200millisecondstomakethat
tradeyoudon'tneedanyspeedinvestmentatall.So,youneedtoconjoinspeedwithHFTorientedknowledge,
period.
Solet'stalkabouttwoofthem:Well,hideinlightorders,whichtherewasn'treallyanamesoIjustpickedthatout
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ofahatandstartedusingit,variousnamesonthedifferentexchanges.Theybasicallycircumventtheadverseimpact
onthebanonlockedmarkets,usingcleverregulatoryworkarounds.So,anotherwaytosayitisHFTshatedprice
sliding,theywantedanotherwaytogetintothecenterandlockmarkets,andthat'swhattheseordertypesdo.They
arekindofhaveyourcakeandeatittooordertypes,becausetheyexploitregulatorykindworkaroundwherethey
gettobeahiddenorderwhenthat'sconvenient,andtheygettobeawhat'scalledaprotectedquotationwhenthat's
convenient.Theyarelikeahybridorder.Sothoseordersarequiteuseful,andthereisalsoRule611.
Rule611actuallypreventedatypeofordercalledanISO,whichwasmeantforlargetraderstosweepacrossthe
orderbook,wellwhathappensisyoucanleveragetheexemptionsofISOs,andyoucanleveragefastpricefeedsto
basicallyplaceordersintradeatpricesthatyoucanjustify.LikeIknewNBBObetterthantheregulatoryfeed,Iam
aheadofeverybody,soyoucanusethislowlatencyspeedadvantagetoactuallytradeatpricesthatthepublic
customeristryingtotradeatandgettingrejected,sothosearetwokeyclasses,therearealotofotherinteresting
thingsthathappen,someofthemaremarketmakerordersthatcandiscriminateeffectively,Idon'tactuallyhave
muchofaproblemwiththose,butthereisalsomidpointorders.Somemidpointordersareorientedtowards
institutions,othersareorientedtowardsHFTs,youhavetoknowwhichonesareHFTonesonwhichexchanges.
Sothesetwoordertypes,whatdotheydo?Theyprovideashortcuttothetopofthequeueandtheyavoidprice
sliding,notallpriceslidingisbad,justcertaintypesofpriceslidingthatHFTswouldconsiderbad,theseordertypes
tendtoavoid.Okay,oneexchangeexplainedthepurposeoftheorderswas"Iteliminatestheneedfortraderstore
trademultipletimesinrapidsuccession,tryingtobehighinpriorityatthenextNBBOprice.Doesn'tthatsoundlike
HFTscalping?SowhenyoureadinthepressthattheseNBBOorderpricesweregenerallyavailableforeveryone,and
theyweren'tcateringaspecificclassofparticipant,well,mostelectronictradingdesksatbanksarenottryingto
rapidlyretryordersmultipletimesinrapidsuccession,tryingtobehighinpriorityatthenextNBBOprice.So,these
areHFTorientedorders,andIwilljustmaintainthatuntiltheend.
Withtheordersthathideorlight,ordersthatlocktheNBBOarehiddeninsteadofrejectedorpriceslid,andseethese
ordersatthebottom?Thoseareactuallyyourlimitorders,right.Youknow,Igetsomecriticism,it'snotwhatyou
mightexpect,HFTssaytome,offline,IhaveemailchainswhenIbecamepubliconthis,thatyouknow,theywould
neveruseregularordertypes,areyoucrazy?Right?These!Ofcourseyouhavetousethese!SoIloveit,likeHFTs
foraverylongtimewerelike"That'sthebreadandbutterordertypesoftheU.S.Market."Youshowthatlistto
anothercrowd,theyarelike"Whatisthat?That'sGreek."Okay?
So,let'stalkaboutordermatchingenginepractices.Thecomplexsequenceofmicrostructureeventstiedtoprice
movesdictateHFTprofitability.So,asIlearnedattradermachinesexchangeorderhandlingisnowaprimaryfactor
impactingexecutionperformanceandslippage.Wewent,youknow,therewasagroupatmyfirmthatwastryingto
addresstheslippageproblembyforecastingthemarket,youknow,certainleans,andwhatyoucouldgetoutofthat
wasnothingcomparedtowhatyoucouldgetoutofusingtheordertypescorrectly.SoHFTspecialordertypesavoid
andinfactbenefitfromdisadvantagesthatfrequentlyimpacttraditionalordertypes,soIonlyhavefiveminutes
here,soIthinkIamonlygoingtodotwomoreslides,soIamgoingtoexplainagainthedarksideofREGNMSprice
sliding.Orderscanbedisadvantagedbybeingkickedtothebackofthequeue,orderscanbepromotedtothefrontof
thequeue,maker/takerfeeallocationcanbeattributedinanopaqueandunusualmanner.Certaininnovationsthat
wereintroduced,IamthinkingaboutoneinJuly2011,createsunexpectedcollisionsbetweensophisticated
participantsandunsophisticatedparticipantsthatotherwisewouldnothaveoccurred.Theimpactonpriceslidingon
ordertypeprecedenceisnotproperlydisclosedbyexchanges.Okay,Iamgoingtogiveyouanexampleofqueue
jumpinghere.
WhenIshowthisslidetoanyinstitutionalcrowdtheyaredoinglargeorders,theyarejustlike"OhmyGod!Theyget
it,"okay?Sowearegoingtoshowhowaninstitutionimproperlyaccessesoneexchangehere.Assumethemarket
forXYZis20.01,20.02offered1000up,institutionwantstosendanonroutableordertobuy10,000for20.02,
thatorderisalsoalockedawaymarket,butit'smarketableonthisexchange,right?Now,again,theysay"wellyou
shouldn'thavesentanonroutableorder!"Ifyouknowhowelectronictradingdesksandbanksoperate,theydon't
liketopayexchangesforroutingfees,sotheysendnonroutableorders.Theinstitutionbuysonly1,000,right?
That'sallthatwasthere,at$20.02.Andwantstopay$20.02foranother9,000.Butheusedthedefaultorder
handlingtreatmentandhewaspriceslidto$20.01,whenhelockedtheawaymarket.Hewasn'tallowedtopostat
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$20.02afterhecleanedoutthat1,000.Thetradingfirm,let'ssaythatyouwereanHFTonthesidelines,therewas
aneutralmarket,therewasnoinformationatall.Thetradingfirmseesthe1,000tradeat$20.02,soheseesthis2
tickwidegap,whichshouldbeconsideredtojumpinthemiddle,andheseesanewpriceslidbidfor9,000,sohe
seestheofferclearedout,and9,000onthebid,nowyouhaveanasymmetricmarket,2tickswide,10,000onthe
bid.Couldyouhave,doyouunderstandhowselfinsuranceworks,andthefactthatthisguyisjusttryingtoflipout
atthesameprice?Youknow,gettinginfrontofthat10,000bidona2tickwidemarketisaquiteobviouscondition
toconsider.
So,thetradingfirmthenstepsaheadoftheinstitutionbypostinga"Hide&Light"hiddenorder,helocksthemarket
at20.02aheadoftheinstitutionalorder,andthiscomplieswithRule610.Meanwhile,aphantomorder,acompletely
unrealorderisdisplayedat20.01onthepricefeed,andthatlookslikeit'sseeminglybehindtheinstitutionalorder.
Howdidyougetthere?Wellactuallytheorderwasaheadofyou,butthepricefeedsaidtheorderwasbehindyou.
Okay?So,iftheinstitutionwassmartenoughtolookintothescreentoseewhatwasgoingon,hewouldthink,
accordingtothefeed,thattherewasorderbehindhim,notaheadofhim,becausethehiddenpieceisahead.Okay,
solet'ssotheawaymarketunlocksandnowthe20.02bidisnowpermissibletolightup,well,theHide&Lightorder
isrebooked,that'sveryimportant,theHide&Lightorderdoesn'tjusttositthereandhaveitscakeandeatittoo,it
hastoberebooked.Asamatteroffact,thephantomorderthatrepresenteditisalsopulledoffthetape,sotheHide
&Lightorderisrebookedaswellastheinstitution'soriginalorder.Theyarebothpulledoffthebookandthenputat
thesameprice20.02butinthisparticularexchangetheydecidedthattheyweregoingtodoaswaparooandput
theHide&Lightorderaheadoftheinstitutionbutifyouthinkabout...ifyouthinkabouttheethicshere,that
institutionasthefullinformationcontent,createdtheconditionwheretheHide&Lightordercouldjumpin,right,he
isexpectingbecausehesentanaggressiveorder,heisexpectingtosetthatnewpricebutthisHide&Lightisgoing
togoaheadofhim.Well,guesswhat,it'snotjustoneHide&Lightorderthat'sgoingtogoaheadofhim,it'sgoingto
bethewholecrowdofHFTs,okay.Iftherearesixguys,hecouldhavecoupleofthousandsharesormoreaheadof
himwhenthemarketfinallylights,sohesitstherehowamIgoingtogettingitdone,youknow,What'sgoingon?
What'sgoingon?Ican'tgetitdone,Ican'tgetitdone,thismarketissotoxic.Ifyoujustusetherightordertypes
andunderstoodtheyarealreadyhandlingtreatmentofthatexchange,itwouldn'tbetoxicatall,actuallywhatwould
youdo?Youjumpinfrontofthisguy.Okay,wearealmostdoneIguess.
Sointhisparticularexample,Isaidthatthelighting,that'simportanttounderstand,it'sthelightingprocesswhen
themarketmoves,okay.LightingunfairlyadvantagesHFTs,youknow,andsoIexplainedthisallbuttheexchange
onfairlylitHFTorientedordersaheadoforderscommonlyusedbyinstitutions...becauseIamrunningoutoftime
here.Well,that'snotall,that'sjusttheonlyonethat'spublic,okay,thereareactuallyfivemajorclassesoforder
whatIcallordermatchingengineabuse,thesetypes.
QueueJumpingtheunfairorderhandlingpracticesthatpermitHFTstostepaheadofinvestororders,it'snotjust
Hide&Lightorders,thatphenomenonappliestootherordertypesandbythewayit'sdifferentoneveryexchange.
CannonfoddertheunfairrebookingandrepositioningofinvestorordersthatpermitHFTstoflippoutoftoxictrades.
Okay,youcoulddebateeverysomeoftheseandsaythat'sokay,orthatwastheintent.Butwhenyoulookatthe
collectiveandyoulookathoweachoneoperatesoneveryexchangeyougetaquiteasymmetricmarketwherethe
publiccustomerisegregiouslydisadvantaged,okay.
FishFoodthisistheonethatreallygotmeactually,theunfairconversionofinvestororderseligibleformaker
rebatesintounfavorableexecutionsincurringtakerfees.Whatdoesthatmean?Well,whenyoucangetrebookedand
havetheorderslidaround,youcanbasicallybeonthebookeligibleforrebateandtheninsomeverystrange
interestingsituation,justbepulledoffthebook,droppedbackonlikeamarketorderyoupaidthetakerfee,and
guesswhatyouexecutedexactlythewrongtimeinthatcase.That's...thatwas...ifanythingwasmybug,itwas
actuallythatone.
Bait&SwitchtheunfairinsertionofHFTintermediariesinbetweenlegitimatecustomertocustomermatching.
CatchMeIfYouCantheunfairanddiscriminatoryorderhandlingofinvestororderduringsuddenpricemovements.

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Iwon'tsaymuchmorenowbut,youknow,frommyperspectivethearticleonme,infromapageofWallStreet
journalinSeptemberthatwasjustoneoflike30thingsonmylistthatirritatedme,butagainthatwasonething
thattheWallStreetJournalfellandtheyhadahardtimedoingit,feltthattheycouldexplaintotheinvestingpublic.
So,wearedonewiththat.Howmuchtimedowehave?Wearedone?
MaleSpeaker1:Wehaveanother5minutes.
HaimBodek:Okay.So,industryforecastof2013inonesentence,thatthingsarechangingandhavebeenchanging
foratleast12monthsbutmostofthesethingsherearenotwellunderstoodbythegreaterinvestmentcommunity,
solotofthingsthatreallyirritatedmethathavebeencleanedupprobablywillnevertolight,butsomewill.That'sit.
MaleSpeaker1:JustliketopointoutthatHaimhasanumberofpiecespostedonthetabforumtalkingaboutthese
verytopics,wouldyousuggesttheyallberead?
HaimBodek:Yeah,actuallyIcollectedeverythingintoalittlebookcalledtheproblemofHFT.Iwasconcernedthat
someoftheargumentswerebeingdiluted,beingspreadacross,andIhavesomenewarticlesinthere,soitbasically
givestheentireblueprint.IfyouwanttodoyourhomeworkIgaveyoutheCliffnotes.Itis100pagesbutitisthe
Cliffnotesforthiswholething.Thereisgoingtobeathinkoutside,Imeantheselittlebookmarks,Idon'thavebooks
today,buttherearebookmarkswhicharekindofglossyandnice,youcanpickthemupandtheywilltellyoualittle
bitaboutthebookandalsosome...itwillpointyoutomywebpage.Also,Ithinkyesterdayordaybefore,Iam
forgetting,theTabforumdidputavideoupwhereIdiscussed...
MaleSpeaker1:Yesterday.Itwasputupyesterday.
HaimBodek:Idisusedthissectionhere.Soifyouwanttogetmyindustryforecastitiskindofembeddedinthat,so
12minutevideo.
MaleSpeaker1:Youwanttotakeonequestion?
HaimBodek:Sure.
MaleSpeaker1:Doesanybodyhaveonequestion?No?Ohokay,rightinthemiddlethere.
FemaleSpeaker:YouarefocusingalotonthepassivestrategyofHFT.Myquestionishowmanystrategiesyou
believearestrictlypassiveversusactiveorothertypesofstrategiesthatarenotbasedaroundthatscalpingasyou
described.
HaimBodek:WellIdon'tthinkitispassiveatall.Ithinkthat'swhateveryoneis...Ithinkpeopledon'tunderstand
thattheseareaggressivecollisionorientedstrategies.Theyaretryingtocomeinandexecuteagainstsomeoneinan
effectivemid.Imeanalotofthetradestheydo,ifyouactuallylookedatitatthetimeofexecutionitwouldlikethey
weregivingupedge.Theyarereallyaheadofthecrowd.Theyarenotpassivelyjoiningthecrowdatall.
FemaleSpeaker:Butisthepurposeofthistheprimaryrebatecapture?
HaimBodek:Thepurposeofitistotradeasignificantamountofvolumeandthisisthemechanismbywhichitis
done,it'snot...thinkaboutHFToriented...thesestrategiesexistedinfuturesmarketwhichdonothaverebate
capture.Thisisjustaclassofhighfrequency,itisaggressive,itisopportunistic,itisineffectpredatorybecauseit
getsaheadofwinds,right,itisnotapassivemarketmakingstrategyatall.Andthat'sactuallywhythesefeatures
areactuallyshouldbequiteusefulforliquiditysecretstoemployiftheywerewellknow.
FemaleSpeaker:Thankyou.
MaleSpeaker1:Okay,well,thankyouverymuch.
HaimBodek:Thanks.
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CopyrightNewstexJun14,2013

Title

HaimBodek'sPresentationToTradeTechOnHFTAndHis
ControversialFindings

Publicationtitle

Phil'sStockWorld[Phil'sStockWorldBLOG]

Publicationyear

2013

Publicationdate

Jun14,2013

Year

2013

Dateline

Jun14,2013

Publisher

Newstex

Placeofpublication

Chatham

Countryofpublication

UnitedStates

Publicationsubject

BusinessAndEconomicsInvestments

Sourcetype

Blogs,Podcasts,&Websites

Languageofpublication

English

Documenttype

Blogs

ProQuestdocumentID

1367684506

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DocumentURL

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Copyright

CopyrightNewstexJun14,2013

Lastupdated

20130615

Database

ResearchLibrary

Copyright2016ProQuestLLC.Allrightsreserved.TermsandConditions

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