Batch Auctions ‘a Better Way’ for IEX; HFT to Accelerate: UMD’s Kyle

SMITH BRAIN TRUST –  Aug. 26, 2016 – The Investor’s Exchange (IEX) and its 350-microsecond trading delay, or “speed bump,” likely won’t revolutionize the industry nor attract a broad range of investors, says finance professor  The Investor’s Exchange (IEX) and its 350-microsecond trading delay, or “speed bump,” likely won’t revolutionize the industry nor attract a broad range of investors, says finance professor Albert “Pete” Kyle at the University of Maryland’s Robert H. Smith School of Business. A “batch auction” approach would more effectively “level the playing field” in the accelerating proliferation of high-frequency trading.

Proponents of the alternative to NASDAQ, the New York Stock Exchange and other public exchanges want the IEX speed bump to limit the ability of high-frequency traders to act on information before it’s seen by smaller traders. But Kyle cautions: “If this amounts to a speed bump that’s uniform, it inherently preserves the incentive to trade faster than the next trader, and the faster trader inherently acquires price information faster, whether fair or not.”

Investor's Exchange IEX

IEX

Batch auctions

A more effective way to “level the playing field” is via “discreet batch auctions,” Kyle says. “Instead of processing one order at a time, orders are batched together, perhaps one order per second. And, to be even more effective, go a step further and randomize the waiting time between the batching of each order.”

Niche, not mainstream

Kyle says the appeal of IEX likely will be limited. One class of investors that would like to see high-speed trading reined in is large-institution asset managers who trade at high volumes, Kyle says. They especially absorb the cumulative cost of engaging in the high-speed, high-volume activity yielding millions of dollars from tiny profits on each trade. The IEX charging a flat fee per every 100 shares bought or sold offsets this cost disadvantage.

Unnecessary counter

NASDAQ’s proposed “extended life” order option to counter the IEX speed bump is questionable, Kyle says. Investors using the function, pending SEC approval, would move ahead of other similarly priced orders if they agree not to cancel their orders for one second. However, “HFTs make much of their money hitting stale orders in the limit order book,” Kyle says. “If the orders are induced to remain for one second, they increase the probability an order is stale and therefore more vulnerable to being picked off by an HFT.”

HFT to accelerate

IEX, with its speed bump and minus a randomizing approach, most likely won’t undo high-frequency trading’s attractiveness and perceived advantages, Kyle says. “And a larger and larger fraction of the market will shift to using HFT technology,” he says. “The technology itself will become. “The technology itself will become commoditized, and you’ll either buy it or rent it from a securities firm or broker that handles your orders.”

The source for this piece, University of Maryland finance professor Albert “Pete” Kyle, is known for creating the “Kyle Model,” which provides a foundation for the modern theory of market microstructure