p.s. Speaking of front-running, the Themis Trading paper I posted a link to here (which I GOT from here days before) is the subject of a John Mauldin newsletter article, and boy is he pissed about it! This pseudo-journalism thing is just so cool… http://www.frontlinethoughts.com/gateway.asp

My understanding of how all this works:

Market Makers (”liquidity provider”) send limit orders to the market (quickly, canceling, replacing, whatever they want, very quickly). These orders are routed to the exchange’s computers and form the order book.

——
Active orders:

Other traders send orders to the market. Again, these orders are routed to the exchange’s computers (i.e. these orders are only seen by other market participants after being filled or placed in the order book). If the order is active, some market participant (probably a market maker, from above) collects the spread (and a liquitidy rebate) and takes the other side and the trader gets his fill (and pays a liquidity demand fee to the exchange — this fee is higher than the rebate for providing liquidity).

At no point do market makers “see” active orders before they are filled. If this is the case, then how is it possible to pursue

“2) ‘latency’ – discovering and then front-running electronic orders or a penny or more by exploding the latency or lag in execution.”

If what I describe above is not true, what is the error I have made?

—-
Passive orders:

Other traders place passive limit orders in the order book alongside other market makers. Once the order is placed and is in the order book, other market participants (including market makers/high frequency traders) can adjust their quotes accordingly. Clearly, the new limit order entering the market reflects demand for shares. Should large numbers of limit orders be placed on one side of the order book, it is likely that the price of the security will increase/decrease (supply and demand at work). High frequency traders/market makers, by their very nature, are the first to react and therefore are most likely to profit.

Is this what the post refers to when speaking of

1) ‘queuing’ [of orders] – finding orders loaded into a system, particularly limit orders, and trading against them;

??

Again, this seems to me to be the only possible explanation. If this is not the case, where have I err’d?

I don’t see how this should be an issue for the marketplace. There has always been someone reacting first to changes in order book dynamics. In the old days, this was the floor specialist when traders had to phone in orders and got delayed quotes and fills. It should not be news that people trading with more latency will have less information about the liquidity dynamics of the market.

—–

So either I have made mistakes in my description of how the market works (very possible, as I really only have a passing knowledge of these issues), or maybe there is some subtle issue that I have missed.

Thanks.

–Stat

Clever, custom programmed, co-located, fast-networked on-site servers at Barry’s place (rackspace.com if you’re curious)?

Nope. A “bug” — I’m on PDT, you are (apparently) on EDT. My timestamps are three hours earlier than yours — WordPress is sorting by local time instead of “universal” time.

So, here’s another chance at frontrunning — who sets an order’s timestamp? If it’s the originator, mayhem is certainly possible!

Having said that, THEORETICALLY, any entity (authorized or otherwise) “between” your order and the book can CONCIEVABLY insert their order(s) ahead of (and/or delay) yours. I’d expect this behavior more of those handling retail orders (as there are more chances due to the number of intermediaries) — in passing, I’ve always been a bit uneasy about the concept of orders filled “in house” first.

Otherwise, it’s either some sort of race (the time between intermediaries is small but non-zero, so perhaps someone watching/communicating at picosecond speeds can get in first), or diddling/rules about order priority (there ARE some rules here, e.g. filling small odd lots to keep these from being frozen out, etc.). I don’t KNOW all of the rules but like most rules, there have to be some favoring the big guys.

Or, this business of “instantaneous” order placement/cancellation to statistically pick off orders in process.

Absent all of that, there is ANTICIPATORY “front-running” — watching stock behavior to predict and order based what’s likely to happen next. I think that’s called “trading.”

Has it occurred to anybody that the furor over the GS code theft is that they’re EMBARASSED by the code?

It would also surprise me greatly if they had any advantage at all on the longer time horizons better associated with investing. Lesson avoid the short term betting game and stick to longer term investing.

“Over the past decade the move to electronic trading and pricing in pennies was heralded by Street insiders as a means to improve liquidity for clients. This appears to be a deception. Virtually every facility benefitted proprietary trading at a select few firms. Who’s the patsy?”

I don’t know how anyone can argue that the costs of trading (including spread) have not been DRASTICALLY reduced.

“Few people realize that exchanges actually pay firms to trade against order flow when they act as a SLP – ‘Supplementary Liquidity Provider’.”

completely wrong. the ENTIRE point is that if you trade against order flow, ie, REMOVE liquidity, you pay, you don’t get paid a rebate. You get a rebate when order flow trades against you. It’s not just semantics, it’s entirely different.

“Anyone with a modicum of industry experience understands that ‘providing liquidity’ is at best a euphemism for front-running order flow. Anyone that regularly ‘provides liquidity’ will go broke.”

this couldn’t be more wrong. I suggest Mr. King sits down with someone who has ever worked on a sell side program trading desk for 15 minutes and clears up his vast misconceptions.

““NYSE fails to explain why proprietary liquidity is more valuable than agency liquidity, or why proprietary liquidity should be favored over agency liquidity.”

it’s not – all liquidity is equally valuable. The SLP program requires the participants to provide a certain amount of liquidity. It’s almost impossible to come up with a conclusion that this is harmful.

Would there be more trading and fewer bankers in government? Would there be a fall in the cynicism titer? Seems like years ago we broke up AT&T into Ma Bell and a bunch of regional phone companies…anyone remember the term “trust busting”?

…just a thought…