This page has been archived and commenting is disabled.

Is SEC Rule 611 The Key To Unlocking the Mystery Behind the IBM "Flash Dash"?

Tyler Durden's picture


A week ago we speculated how the well documented flash smash in IBM caused a market wide ramp, resulting in another attempt at closing above 1,300. It failed. But the mechanics behind the trade still were unexplained. Below, we present a summary by Dennis Dick which highlights the latest weakness in market structure which the mini melt up in IBM (and, subsequently, in ES) has exposed. The only question: was this trade a glitch, or was someone trading fully aware of the limitations of SEC rule 611. (which, incidentally, has some very interesting exemptions, such as "qualified contingent trades" a topic touched by us tangentially previously).

Unlocking the Mystery Behind the IBM "Flash Dash", of Trading Defendes


On Tuesday afternoon,
at 3:15 pm, IBM was trading strong, up over a point at 160.76, when
suddenly at 3:18:15 pm the stock spiked to 164.35, and immediately
traded back down to the 160.76 area.  This series of trades all occurred in the same second.  What happened?  What was the cause of this sudden "Flash Dash"?


The answer is a testament to the fragmented liquidity in our current market structure.  SEC
rule 611, the order protection rule is designed to prevent
"trade-throughs" - trades being executed at prices inferior to the
best-priced quotations.  But this rule may not go far enough because it only protects the top of the book.


Consider the following example:


Security XYZ


Order book on Ask:


500  32.00 INET

500  32.01 INET

500  32.02 ARCA


ARCA receives a market order to buy 1000 shares of XYZ, and the best available offer is on INET for 500 shares.  ARCA
must route the first 500 shares to INET, so as to not violate the order
protection rule (because the 500 shares on INET is at the top of the
book and is therefore a "protected quotation").  After
that, the remaining 500 shares can be filled back on the original
exchange that received the order, in this case ARCA, regardless of
whether there is better quotations on other trading centers. 


In this case, 500
shares would be executed against the 32.00 INET offer, and the remaining
500 shares could then be executed against the 32.02 ARCA offer.  The 500 shares offered at 32.01 on INET would remain unfilled.


The buyer in this case actually pays a penny more than they should of had to for the last 500 shares.  That
is because the only "protected quotation" is the top of the book which
in this case is the 500 shares offered on INET at 32.00.  


In the IBM case from
January 25th, it appears a trader sent a buy order for approximately
60,000 shares and routed this order to the NYSE.  The
NYSE routed the first part of the order to the NBBO offer of 160.76, so
as to not violate the order protection rule, and then filled the
remaining shares on the NYSE exchange. 


Here's the tape of all trades occurring at 15:18:15 EST:


Time & Sales       Ticker:  IBM           Date:  January 25, 2011                                 

Time                Last                 Size (00s)         Time              Last                 Size (00s) 

15:18:15          160.76             8                      15:18:15          161.33             2                  

15:18:15          160.76             8                      15:18:15          161.36             2        

15:18:15          160.77             2                      15:18:15          161.53             10

15:18:15          160.78             1                      15:18:15          161.65             22

15:18:15          160.79             5                      15:18:15          161.72             10

15:18:15          160.80             8                      15:18:15          162.00             80

15:18:15          160.81             3                      15:18:15          162.20             10

15:18:15          160.82             8                      15:18:15          160.79             1

15:18:15          160.83             19                    15:18:15          162.22             2

15:18:15          160.84             6                      15:18:15          162.24             1

15:18:15          160.85             4                      15:18:15          162.38             1

15:18:15          160.76             1                      15:18:15          162.48             1

15:18:15          160.86             21                    15:18:15          162.69             2

15:18:15          160.87             14                    15:18:15          162.84             48

15:18:15          160.88             7                      15:18:15          160.78             1

15:18:15          160.89             15                    15:18:15          160.78             1

15:18:15          160.78             1                      15:18:15          162.86             1

15:18:15          160.90             15                    15:18:15          162.87             2

15:18:15          160.91             3                      15:18:15          162.88             4

15:18:15          160.92             23                    15:18:15          162.89             5

15:18:15          160.81             2                      15:18:15          162.92             2

15:18:15          160.93             9                      15:18:15          162.93             4

15:18:15          160.94             8                      15:18:15          162.94             2

15:18:15          160.95             2                      15:18:15          162.95             3

15:18:15          160.97             4                      15:18:15          162.96             15

15:18:15          160.98             8                      15:18:15          160.79             1

15:18:15          160.99             1                      15:18:15          160.89             2

15:18:15          161.00             4                      15:18:15          160.89             2

15:18:15          161.02             1                      15:18:15          163.22             1

15:18:15          161.07             1                      15:18:15          163.77             122

15:18:15          161.09             5                      15:18:15          164.12             1

15:18:15          161.10             1                      15:18:15          164.26             70

15:18:15          161.13             2                      15:18:15          164.35             2

15:18:15          161.21             1                      15:18:15          160.78             1

15:18:15          161.22             4                      15:18:15          160.76             1

15:18:15          161.30             1                      15:18:15          160.76             3

15:18:15          161.31             8                      15:18:15          *63 trades 160.76-160.86

* I omitted the last
63 trades that occurred at 15:18:15, as they were all between the
prices of 160.76 and 160.86 (possibly algorithmic traders buying back
stock on the other exchanges that they just sold on NYSE exchange).


This series of trades exemplifies the lack of protection for depth of book quotations.  There
was a significant amount of additional liquidity on the other exchanges
as the consolidated offer never exceeded 160.86 during the time frame
under question.  However, because the order
protection rule only protects the top of the book (160.76 in this case),
trades can occur at inferior prices despite there being liquidity on
other trading centers.


The NYSE did nothing wrong in this case and they should not be villainized.  The
problem lies in the order protection rule, and maybe the SEC should
consider expanding this rule to provide protection to the depth of book


This IBM incident is not an isolated case.  These trade-throughs occur every day, just usually on a smaller scale as in my first example.  They can sometimes occur on larger scales, especially on exchanges with less liquidity.  The
media often reports these incidents as "mini flash crashes" (or mini
flash dashes in the case that the stock spikes higher).


These incidents are
nothing more than a testament to the fragmented liquidity that is
indicative of our current market structure.


As more and more exchanges are created, traders need to be more aware of how their orders are routed.  In the IBM case, the trader could have sent the order using some type of "smart" order router.  This order type would have sought out liquidity on all exchanges (as well as available undisplayed liquidity). 


Unfortunately, not
all traders understand how their orders are routed and therefore it may
become necessary for the SEC to expand the order protection rule to
include depth of book quotations.  Otherwise as the market structure becomes more and more complex, expect trade-throughs like the IBM case to become the norm.


- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Mon, 01/31/2011 - 13:40 | Link to Comment OMG
OMG's picture

DOW 36,000 will not be denied.





Mon, 01/31/2011 - 17:48 | Link to Comment overbet
overbet's picture

Are you people kidding? There is one born ever the world a favor and keep your dumb money out of the market and donate it to a charity instead of a banker. This is a algo malfunction. From Thursday 27th......same day both tickers roughly same volume per day. Here look at the following:

NASDAQ has reviewed the transactions under rule 11890 (b) on its own motion filing involving the security Berkshire Bancorp Inc. "BERK" executed between 09:42:00 and 09:44:00 ET today and has determined that all trades will stand. This decision cannot be appealed. NASDAQ MarketWatch has coordinated this decision with other UTP Exchanges.

From the same day for ticker SFLA:

Pursuant to Rule 11890(b) NASDAQ, on its own motion, has determined to cancel all trades in security iPath LX S&P 500 TR Index ETN (SFLA) at or below $57.48 that were executed in NASDAQ between 09:21:00 and 09:22:00 ET. This decision cannot be appealed. MarketWatch has coordinated this decision with other UTP Exchanges. NASDAQ will be canceling trades on the participant’s behalf.


Theses trades get busted that were $4 away on a $57 stock but the trades on this BERK that were $13 away stand?

Everything is legit here nothing to see move along....

Mon, 01/31/2011 - 17:49 | Link to Comment More Critical T...
More Critical Thinking Wanted's picture

In the IBM case, the trader could have sent the order using some type of "smart" order router.  This order type would have sought out liquidity on all exchanges (as well as available undisplayed liquidity). 

Wow - this is a historic moment, this is the first time ever that ZH advocates the use of HFT algos to trade more efficiently.

And yes, I agree, doing this makes a lot of sense.

The world is distributed (blame that on tectonic activity), and unless you want to force all liquidity into one centrally planned entity, the libertarian, "free market" solution is smart routing algos.

Smart people use smart algos.

Mon, 01/31/2011 - 17:49 | Link to Comment More Critical T...
More Critical Thinking Wanted's picture


Mon, 01/31/2011 - 13:43 | Link to Comment SparkyvonBellagio
SparkyvonBellagio's picture

Audit the SEC, FED, and all of its members.

I can only guess how many unmarked manila envelopes end up on these peoples doorsteps or pushed through their mail slot at home. Payoffs galore.


Try them all for Treason!



USA is a 3rd World country with nukes.








Mon, 01/31/2011 - 13:47 | Link to Comment SheepDog-One
SheepDog-One's picture

Rules? Shocking...I wasnt aware there were any at all.

Mon, 01/31/2011 - 13:48 | Link to Comment 4xaddict
4xaddict's picture

Interesting post, would love to read more about this as it comes to hand!

Mon, 01/31/2011 - 13:51 | Link to Comment Convolved Man
Convolved Man's picture


The dreaded "do what I say and not what I mean" codification syndrome.

Mon, 01/31/2011 - 13:53 | Link to Comment dirtydroog
dirtydroog's picture

What the f**k am I looking at?

Mon, 01/31/2011 - 14:02 | Link to Comment Bearster
Bearster's picture

Sure that makes sense Tyler.  People who don't understand are a reason why the government should coercively implement more regulations.

Just don't be surprised if the new rules are the product of backroom dealmaking between GS and the SEC, and turn out to GS' benefit and the harm of everyone else...

Mon, 01/31/2011 - 14:10 | Link to Comment I am a Man I am...
I am a Man I am Forty's picture

why would he not use a limit order?

Mon, 01/31/2011 - 14:11 | Link to Comment Burgess Shale
Burgess Shale's picture

Thanks Dennis.  Nice to see someone analyzing these spikes.

Mon, 01/31/2011 - 14:19 | Link to Comment pragmatic hobo
pragmatic hobo's picture

because limit orders have tendency to not get filled?

Mon, 01/31/2011 - 15:08 | Link to Comment dan10400
dan10400's picture

because they are sitting ducks for being front run?  baddah-bing!

Mon, 01/31/2011 - 15:50 | Link to Comment Buttcathead
Buttcathead's picture

wud ever... it's all fake anyways.  U know it's all Bernacks fake ass money.  I aint buy'n nuttin.

Mon, 01/31/2011 - 15:53 | Link to Comment ThirdCoastSurfer
ThirdCoastSurfer's picture

Wow! This really explains a lot about all the odd stuff L2 shows. I recently read, but cannot find, an article (also a CNBC report) that explains how exchanges provide a bonus to brokers for providing,  and a penalty for extracting,  net liquidity to the exchange. The example was how $1,200 can be made daily by routing a million shares of C to a specific exchange -or something to this effect- which also explains a piece of why this situation is allowed. 


Mon, 01/31/2011 - 16:10 | Link to Comment slewie the pi-rat
slewie the pi-rat's picture


thanks tyler.

60K no problem 4 a limit order.

maybe the buyer was closing a spread, tho.  maybe he was short 600 160's and the broker decided to flush.  other than that, stupid is what stupid does.

we learn from our mistakes.

the customer makes the order, not the broker.

if no hurry, why not just go in with a limit of  161.00/all or none.

that might take another second, but why, really? this is big blue, for pete's sake.

they only nicked him 4 about $80-100K + the vig on $10mil., i didn't do the math.

jeeez!  the li'l squids & their kids gotta eat, too.

this is a bit over the top, tho, even 4 squids.

back w/ a specialist, no way this could happen, i would opine, in this stock.

161.25 tops, with no ghost at the post, doncha think?

Mon, 01/31/2011 - 16:41 | Link to Comment FrFacstory
FrFacstory's picture

Their are companies that make money on this arbitrage of the market

Do NOT follow this link or you will be banned from the site!