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Broken Market Chronicles: Nasdaq Proposes To Make Legal What Exchanges Have Been Doing Illegally For Years

Tyler Durden's picture





 

A new proposal by Nasdaq has the market purists such as our friends at Nanex and all those (very few) who still care about how broken the market is and demand something be done about it, writhing in disgust, particularly this section:

\5\ The Exchange is also changing its policies and procedures under Regulation NMS governing the data feeds used by its execution system and routing engine. Current policies state that those systems use data provided by the network processors. In the future, those systems will use data provided either by the network processors or by proprietary feeds offered by certain exchanges directly to vendors.

Nasdaq's proposal admits that exchanges are supposed to use the SIP (CQS/UQDF) data for their execution system and routing engine! They want to formally change things to match what they've been doing all along so they can avoid fines and more! Why would you submit a proposal to change something you've already been doing? In other words, what the exchange is proposing, is already common practice. If exchanges are granted this proposal, Reg NMS, for all practical purposes, is no longer relevant, and there is no point in having the SIP calculate the NBBO, because it will have no meaning. Translated: the market will be, for all intents and purposes, officially two-tiered and terminally broken.

The exchanges are NOT currently using data provided by the network processors (SIP). Exchanges have been using data from proprietary (direct connect) feeds to other exchanges for their execution systems and routing engines at least since the flash crash. There are events every day that prove this is the case, such as the one below. Other evidence can be found in events such as when quotes get delayed, sometimes for minutes, yet trades occur as if there were no delay. Essentially, this behavior, and the proposal, breaks the trade-through price protection feature of Reg NMS.

In other words, what the exchange is proposing, is already common practice. If exchanges are granted this proposal, Reg NMS, for all practical purposes, is no longer relevant, and there is no point in having the SIP calculate the NBBO, because it will have no meaning.

If the proposal is not granted, will the exchanges finally start using data provided by the network processor? Or will it be business as usual?

Then again, the ponzi has bigger fish to fry than proper market functioning. And with the traditional bullish HFT bias, why on earth would anyone in charge make it more difficult to levitate markets?

Of course, one can dream...

 


As a reminder:

Reg NMS Has Been Rescinded! HFT no longer bound by Trade Through Rules

On October 7, 2011 beginning at 12:03:39.950, a massive surge of quotes in SPY, IWM, DIA and other market index ETFs, along with many symbols in the Dow Jones Industrial Average, caused an overload in CQS that lasted several seconds. This, in spite of a 25% increase in CQS capacity just 3 days earlier to a whopping 1.25 million quotes/second. During this event, Nasdaq quotes into CQS became delayed at least 800 milliseconds (800,000 microseconds). Other exchange quotes feeding into CQS also became delayed.

We found many symbols with trade executions that appeared several hundred milliseconds before the quotes that could have produced them. How does one ensure trade-through price protection if the price being protected hasn't even occurred yet?

Given the evidence from this event, we have to conclude that Reg NMS must have been secretly rescinded: at least the part that talks about trade through price protection, the NBBO (why is it still being computed?), and the importance of keeping the feed affordable.

From the data we have looked at so far, we estimate that CQS capacity needs to be increased to at least 6 million quotes/second in order to avoid becoming overloaded.  This would be the capacity for a normal trading day. The capacity to handle a surprise news event, would of course, need to be much, much, higher. 

To be clear, we are not advocating increasing CQS capacity at all, mostly because all this extra quote traffic is pure non-sense and has no value what-so-ever. It's mostly coming from new HFT, and interactions between HFT algorithms trying to out fool each other. Something that a regulator doing their job would have put a stop to a long time ago.

The next time the market receives a shocking news story, or undergoes unusual stress, the only traders who will have accurate market prices will be those co-located at the exchange. Just like on May 6, 2010.

 


Below is a 5 millisecond interval chart of SPY showing Nasdaq trades (circles) and quotes (shaded vertical lines). The distance between the points labeled A and a is the minimum time that trades came ahead of quotes.



Below is a 5 millisecond interval chart of SPY showing quotes from EDGE (blue) and Nasdaq (black). The distance between the points labeled A and a is the approximate amount that Nasdaq quotes were delayed relative to EDGE.



The chart below shows the quote rate per exchange going into CQS over the same period and interval as the charts above. The bottom panel shows each exchange's quote rate as a percentage of all quotes going into CQS. You can see the wild oscillations in the red line (Nasdaq) correspond to the dribbling of quotes in SPY above (Between 12:03:40.050 and 12:03:40.800).  Around the 12:03:40.800 mark, Nasdaq quotes suddenly surge accounting for more than half of all quotes going into CQS. If you look closely, you will see other exchange quote rates also oscillate at this time in a round-robin fashion.



Below is a close-up of of the chart above, with a few exchanges removed for clarity.



Below is a 5 millisecond interval chart of IWM showing quotes and trades from BAYS (purple) and Nasdaq (black). Here, Nasdaq quotes are delayed, but so are the trades.



Below is a 5 millisecond interval chart of IWM showing quotes and trades from ARCA (red) and Nasdaq (black). You can see ARCA trades (red circles) are coming before the quotes (red vertical lines) that executed them.


 


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Sun, 10/30/2011 - 12:45 | Link to Comment Schmuck Raker
Schmuck Raker's picture

Sooo..."If it ain't 'fixed', break it?"

Sun, 10/30/2011 - 12:48 | Link to Comment Dental Floss Tycoon
Dental Floss Tycoon's picture

One market for the big boys and a little toy market for us.

So what changed?

Sun, 10/30/2011 - 15:50 | Link to Comment whstlblwr
whstlblwr's picture
Translated: the market will be, for all intents and purposes, officially two-tiered and terminally broken.

Translated: the market controlled by government. Bailout for insiders only. One market for government manipulations and no free market for us.

We need class action lawsuit against SEC.

Tue, 11/01/2011 - 07:56 | Link to Comment Ted K
Ted K's picture

This is a scam run by private brokerages and ETFs.  So it's the brokerages in FINRA causing the price manipulations, not the "evil gov".  If you had reading comprehension past the Glenn Beck level you'd know that, you damned idiot.

Sun, 10/30/2011 - 12:54 | Link to Comment Racer
Racer's picture

Yes thoroughly break it so no human life form will touch it and  the snakes feed on themselves until they eat their own tails

Sun, 10/30/2011 - 12:45 | Link to Comment ziggy59
ziggy59's picture

It's called CYA! If you make crime legal, no one goes to jail.

Sun, 10/30/2011 - 12:45 | Link to Comment disabledvet
disabledvet's picture

This is a little too inside baseball for me. All it makes me think of is Europe trying to scuttle the deal between the NYSE and Deutche Bourse as "monopolistic." A "monopoly in trading activity" for the entirety of an equity exchange would quite a monopoly indeed. It might "push" it's only true rival (the Nasdaq) in a "regulatory aggressive" direction.

Sun, 10/30/2011 - 12:49 | Link to Comment LawsofPhysics
LawsofPhysics's picture

Wow, just wow.  Of course this makes sense, a properly functioning free market with true price discovery would not allow all the manners of skimming we have already.  No way anyone currently profiting from these markets wants a properly functioning market.  Especially the big boys.

Sun, 10/30/2011 - 12:51 | Link to Comment 0cz
0cz's picture

This is just setting up the legal framework for when Goldman Sachs will soon use quantum entanglement technology to not only manipulate the markets now, but they will soon be able to manipulate the markets in the past, present and future. 

Looks like my degree in temporal mechanics and quantum spintronics is going to be useful after all!

Goldman Sachs has been hunting for a technology they can use to increase the effeciency of their conquest to steal wealth from people before the wealth even exists.

Sun, 10/30/2011 - 13:35 | Link to Comment Uncle Sam
Uncle Sam's picture

"We found many symbols with trade executions that appeared several hundred milliseconds before the quotes that could have produced them."

This is no different from what they proved at CERN, that Einstein was wrong and electrons can travel faster than the speed of light. This is quantum disentanglement, and does prove it is possible to steal wealth before wealth even exists.

The creation of the Federal Reserve, despite 'The Creature From Jekyll Island', is nothing more than a 'quantum time machine future wealth absorbption unit'. It is the pinnacle of German engineering, and we should wholeheartedly embrace it. They clearly have our best interest at heart. Financial science is our friend.

Or not.

Sun, 10/30/2011 - 13:52 | Link to Comment Darth..Putter
Darth..Putter's picture

Bet you were surprised when you found all the formulas were already there in the ancient religious texts, poetry, and fairy tales. 

 

Zombie Markets Unite!!

Sun, 10/30/2011 - 14:46 | Link to Comment slewie the pi-rat
slewie the pi-rat's picture

this is a fabulous post, uncle sugar!

tyler can give it to his cat, schrodinger, as a tricky halloween treat

you and darth have been puttering around here for about the same short time, but i have be4en playing blackjack elimination tournamen-toes all morning, so rather than get too suspicious, i'll just say hi and welcome to the boards, BiCheZ!

Sun, 10/30/2011 - 12:52 | Link to Comment GeneMarchbanks
GeneMarchbanks's picture

Looting looters....

Sun, 10/30/2011 - 12:57 | Link to Comment SheepDog-One
SheepDog-One's picture

NASDAQ lol didnt Bernie Madoff invent that scam? Why even try to hide it anymore, the markets are a jerry-rigged joke.

Sun, 10/30/2011 - 13:04 | Link to Comment pauhana
pauhana's picture

I have waited in vain for the SEC and/or the CFTC to do something about the quote stuffing of HFTs and their constant skimming thoughout the trading day.  How many times have we had concrete proof of what's going on only to face complete silence from the regulatory agencies?  What more proof do they need to know that this market is totally rigged for the benefit of those co-located super computers?  This isn't even a casino.  It's a disgrace.  There isn't even a pretext of protection for the small investor and yet . . . . It's enough to drive this 65 year old into the streets with the rest of the OWS protesters, for whatever good that will do.  

Sun, 10/30/2011 - 14:56 | Link to Comment traderjoe
traderjoe's picture

They are the defenders of the system. The system was set up to steal from you. The system is operating within its design parameters.

Sun, 10/30/2011 - 13:04 | Link to Comment HD
Sun, 10/30/2011 - 13:06 | Link to Comment maxw3st
maxw3st's picture

It looks like the problem is three-fold. 1. Regulators are ignoring, or incapable of understanding the significance of the charts and data above and 2. The market is not being run through a single, integrated quote/execution system. 3. Trades are being executed arbitrarily, it would appear, based on the presumption of price rather than an actual open-interest-auction derived price. This is occurring due to a lack of coordination between multiple trading systems. A quote is made available on one system and HFT's run trades according to that price. That strike price is not being reported to other involved systems until after the trade is run. This means that those receiving quotes and trading accordingly are not getting the same opportunity to trade "at the market" the HFT's are trading at. Simply put, HFT's are front running the exchanges to the detriment of all investors other than those with HFT capacity. The easiest way to correct this would simply be to block those trades until all involved systems are reflecting the same bid and offer for every security involved. ie. before that HFT trade is run according the quote from one system that system needs to check the others to assure that all are reflecting the same quote.

Once executed, of course, a trade will probably affect the price quoted. Before a second trade is run a check needs to be made that all systems have been updated to reflect the volume data and subsequent price changes involved. In short, the trading platforms need to be brought into sync. before trades are executed, not after the fact. Removing this source of arbitrage that HFT's have been exploiting would probably dramatically decrease the volume of HFT trading.

And that gets to the real problem here. It's probable that none of the trading system operators want to do anything to decrease the volume of HFT trades since they get paid transaction fees for each trade. They are desperately hoping the system is  complex enough that nobody (other than HFT algo's) will notice it's going on.

Bottom line is that if you want to have the fair, electronic trading system that most believe they are using then all these different platforms need to run through a common filter that provides bids and offers to all trading platforms at the same time.

Sun, 10/30/2011 - 13:08 | Link to Comment pauhana
pauhana's picture

Can I get an "amen?"

Sun, 10/30/2011 - 14:35 | Link to Comment paulbain
paulbain's picture

MaxW3st wrote:

 

 

It looks like the problem is three-fold. 1. Regulators are ignoring, or incapable of understanding the significance of the charts and data above and 2. The market is not being run through a single, integrated quote/execution system. 3. Trades are being executed arbitrarily, it would appear, based on the presumption of price rather than an actual open-interest-auction derived price. This is occurring due to a lack of coordination between multiple trading systems. A quote is made available on one system and HFT's run trades according to that price. That strike price is not being reported to other involved systems until after the trade is run.

 

 

 

Max West, thank you for explaining this matter in layman's language. I still do not completely understand the problem, but your explanation greatly helped me nevertheless. Tyler Durden's explanation, by contrast, confused me completely.

 

-- Paul D. Bain

paulbain@pobox.com

Sun, 10/30/2011 - 21:21 | Link to Comment myne
myne's picture

It could be as simple as clock squew at those timeframes.

Essentially, the servers will be synching with Network Time Protocol. A protocol that runs over the internet. By nature this means it is not perfect.

The timing signal is then updated and synchronised with the mainboard's onboard crystal. Another source of unreliability. They're accurate enough for most things, but a single cycle per second less than the benchmark will add up over time. Let's say it's a relatively standard 30,000hz crystal running at 29,999 hz. After 1 hour it's down 3600hz which amounts to 1.2 millionths of a second.

Sun, 10/30/2011 - 13:15 | Link to Comment navy62802
navy62802's picture

Got gold?

Sun, 10/30/2011 - 13:16 | Link to Comment ArkansasAngie
ArkansasAngie's picture

My daughter just sent me a photo of a sign that says "Jail the banksters -- Free Pot Smokers"

Now that's a philosophy that I can get on board with. 

Sun, 10/30/2011 - 13:21 | Link to Comment SilverDoctors
SilverDoctors's picture

Zerohedge should start a pool on if/when there will ever be the first bankster jailing from this mess...

http://silverdoctors.blogspot.com/

Sun, 10/30/2011 - 13:25 | Link to Comment HD
HD's picture

What would be the point if everyone picks "never"....

Sun, 10/30/2011 - 13:31 | Link to Comment adr
adr's picture

That is pretty easy. The answer you are looking for is never.

A better pool is which day will a chairman of Goldman be thrown from the top of a NY highrise by an angry mob?

Sun, 10/30/2011 - 13:35 | Link to Comment JR
JR's picture

This is what it looks like at the end; you can’t live on paper. Ask anybody in Zimbabwe.

Sun, 10/30/2011 - 14:02 | Link to Comment prophet
prophet's picture

Is that a Jack-o'-latern I see in those NANEX charts?

Sun, 10/30/2011 - 14:05 | Link to Comment max2205
max2205's picture

Hence 'late tape' in this day and age

Sun, 10/30/2011 - 14:59 | Link to Comment billsykes
billsykes's picture

Would this be akin to what used to happen in the pits when a trade was placed for a customer- slipage?

Sun, 10/30/2011 - 15:13 | Link to Comment Bansters-in-my-...
Bansters-in-my- feces's picture

Fuk You...Uncle Sam.

Sun, 10/30/2011 - 16:37 | Link to Comment dizzyfingers
dizzyfingers's picture

All suspicions are now confirmed?

Sun, 10/30/2011 - 17:03 | Link to Comment Carnegie_IB
Carnegie_IB's picture

Broken yes. but what difference does this make if I am trading periodicity longer than miliseconds? ie. trading 15 min, 30 min, 60 min, daily price moves? 

Sun, 10/30/2011 - 17:11 | Link to Comment Caviar Emptor
Caviar Emptor's picture

Back to a system like in the 1900s: trading INside the exchange, and trading OUTside the exchange on the actual street (hence the slang term "what the street sez" )

Sun, 10/30/2011 - 18:35 | Link to Comment catch edge ghost
catch edge ghost's picture

Oh crap.  Another world-as-we-know-it-ending systemic shift that will go ignored by nearly all of the people it harms.

I should spend days better educating myself so that I might educate others and create awareness. I'll read every paper, every proposal, every everything ever written by everyone ever named Saluzzi or posted by Nanex. I will win this time.

Because the truth always wins out. And let us never forget the Spirit of 1776 and Liberty and America and, um, uhh, Truth and Justice, and Change, and America. 

I like clipper ships.

Sun, 10/30/2011 - 23:06 | Link to Comment swani
swani's picture

Join OWS bitchez!

But seriously, isn't there an anti-trust issue here? Isn't there a law suit? Something?

I mean the mood is right to take action. It's now or never.   

Mon, 10/31/2011 - 02:34 | Link to Comment connda
connda's picture

The market's already broken.  Now their just grinding the remains into dust.  The big pieces go to the 0.01%.  The dust goes to the 99.99% of the peons.  Let them eat cake -- or iPods.

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