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Hidden Orders: A useful tool in a trader’s tool box to defend against predatory HFTs
Ever since the publication of the book Dark Pools in 2012, it became public that ECNs and exchanges were accommodating HFTs firms by offering them special order types that most market participants don’t get. These order types enable HFTs to decrease the amount of “adverse selection” they are exposed to and to be at the top of the queue, key components of profitable market making.
Most HFTs firms have dozens (if not hundreds) of special order types at their disposal by exchanges and ECNs. Retail traders who want to be able to fight back and cut down their trading costs should learn and implement useful order types that are available to them.
There is an interesting tool that is not very well known by traders that can help you decrease the amount of HFT “gaming” your orders suffer. Hidden “native” orders are orders that sit on an ECN or exchange and that, in theory, are not seen by anyone. I say in theory because the exchanges/ECNs have broken the rules before in order to accommodate HFTs. It’s possible but unlikely that some of them have leaked information about hidden orders at some point.
These orders are different from iceberg/reserve orders, iceberg orders show up on the Level 2 window and on the direct feed data that HFTs receive. They usually appear as 100 shares and give HFTs an opportunity to “penny jump” the order by going in front of it by 1 cent. This exposes the order to adverse selection, meaning they will get out of the way when they see a shift in the short-term supply and demand and stay ahead of you by 1 or a few cents when they don’t. You tend to miss out on fills that you want and get fills that you don’t want.
Lots of traders report the experience of having a stock move down or up right to the point that their limit order is not get filled by one cent (or get partially filled). Sometimes this happens due to randomness, but a lot of the time this happens because HFTs use passive non-HFT orders as insurance. If they are bidding for a stock, they know that if they get ahead of you by 1 cent, they can get their fills and try to sell on the ask. If all goes well, they make the spread, if it doesn’t and the stock looks to drop, they dump their shares into your orders. You get your fill but now you are also underwater in the trade (or you left money on the table for a buy to cover order while exposing yourself to a squeeze).
A useful way to diminish this passive order gaming is to use “native” hidden orders. With these orders, the HFTs tend to only find out where your orders are after they have been executed (whether in full or partial). Let me give you an example: Let’s say you are short 1,000 shares of stock ABC, it’s trading at $35, it then proceeds to drop as you expected. You decide to take profits in the $34.60-$34.65 area because you think there will be some support at $34.50. You put a hidden buy order for 500 shares of ABC, native to ARCA at $34.64, 200 shares at $34.63 native to NSDQ and 300 native to NYSE at $34.63. When I say native to the ECN/exchange, I mean that it will only interact with the order flow of that ECN/exchange. For instance, if someone sells 500 shares of ABC at $34.64 at NYSE, you will not get filled because your hidden order was sitting at ARCA. Hidden orders can even be traded through, meaning, you can see prints bellow the price of your buy order. This disadvantage can be countered by using what I call a hidden order “net”. You use several ECNs/exchanges that have the most volume, instead of just one. That way you have multiple order flows to interact to.
By having your orders distributed that way, when the stock drops and stops in the $34.60s area, you will avoid being used as insurance for HFTs looking to make markets. If the stock really drops quickly, say from $35 to $34.50, it won’t make much of a difference whether you are using hidden or lit (displayed) orders. It’s on the marginal situations where your orders are on the bottom or close to the bottom that hidden orders can decrease your trading costs by exposing you to less adverse selection.
With the lit orders, having the HFTs penny jump you and prevent you from getting filled at or close to the bottom can cost you significant profits as the stock reverses higher and you are forced to hit the ask in the $34.70s area. With the hidden orders, the HFTs can still game you in a similar fashion but they can do it only after they find out that there are hidden orders at a certain level. In a fast moving stock with good volume, by the time they find out, it’s too late. Your order is likely to at least have been partially filled.
In addition, HFTs don’t like hidden orders because even though they can find out that they are at a certain level, they don’t know when they get cancelled or entirely filled and the free insurance is gone. They do like to use a trick against these orders, odd lot trades. Sometimes, in order to find out if there are hidden orders in an exchange/ECN they will send out orders for a tiny amount of shares (usually less than 50). When they discover the hidden liquidity, they can penny jump it or just keep sending odd lot orders to annoy and/or increase the trading costs of the trader behind it.
Routing a Hidden Order Net
Which routes to use to best increase the change your hidden order net will capture most of the volume in a particular stock? You have to be aware of where, currently in the US, most of the volume is going through. As of September of 2014, volume is distributed as follows:
Source: BATS Exchange.
By the table, you can see that in a NASDAQ stock (Tape C), NASDAQ and ARCA do most of the volume (over 37%). For a NYSE stock (Tape A), NYSE and ARCA do most of the volume (about 31%). For AMEX stocks (Tape C), ARCA and NASDAQ do most of the volume (about 38%).
When routing your net in a NASDAQ stock, the better routes are NASDAQ (sometimes still called Island by some brokers) and ARCA as a secondary route. When trading a NYSE stock, the better routes are NYSE and ARCA. For AMEX, ARCA is the main one and NASDAQ is a secondary route."
due character limit of ET rest of the article at:
http://www.beathft.com/?p=88
Anyone agrees or disagrees with this? Any technical flaws in the article?
Hidden Orders: A useful tool in a trader’s tool box to defend against predatory HFTs
Ever since the publication of the book Dark Pools in 2012, it became public that ECNs and exchanges were accommodating HFTs firms by offering them special order types that most market participants don’t get. These order types enable HFTs to decrease the amount of “adverse selection” they are exposed to and to be at the top of the queue, key components of profitable market making.
Most HFTs firms have dozens (if not hundreds) of special order types at their disposal by exchanges and ECNs. Retail traders who want to be able to fight back and cut down their trading costs should learn and implement useful order types that are available to them.
There is an interesting tool that is not very well known by traders that can help you decrease the amount of HFT “gaming” your orders suffer. Hidden “native” orders are orders that sit on an ECN or exchange and that, in theory, are not seen by anyone. I say in theory because the exchanges/ECNs have broken the rules before in order to accommodate HFTs. It’s possible but unlikely that some of them have leaked information about hidden orders at some point.
These orders are different from iceberg/reserve orders, iceberg orders show up on the Level 2 window and on the direct feed data that HFTs receive. They usually appear as 100 shares and give HFTs an opportunity to “penny jump” the order by going in front of it by 1 cent. This exposes the order to adverse selection, meaning they will get out of the way when they see a shift in the short-term supply and demand and stay ahead of you by 1 or a few cents when they don’t. You tend to miss out on fills that you want and get fills that you don’t want.
Lots of traders report the experience of having a stock move down or up right to the point that their limit order is not get filled by one cent (or get partially filled). Sometimes this happens due to randomness, but a lot of the time this happens because HFTs use passive non-HFT orders as insurance. If they are bidding for a stock, they know that if they get ahead of you by 1 cent, they can get their fills and try to sell on the ask. If all goes well, they make the spread, if it doesn’t and the stock looks to drop, they dump their shares into your orders. You get your fill but now you are also underwater in the trade (or you left money on the table for a buy to cover order while exposing yourself to a squeeze).
A useful way to diminish this passive order gaming is to use “native” hidden orders. With these orders, the HFTs tend to only find out where your orders are after they have been executed (whether in full or partial). Let me give you an example: Let’s say you are short 1,000 shares of stock ABC, it’s trading at $35, it then proceeds to drop as you expected. You decide to take profits in the $34.60-$34.65 area because you think there will be some support at $34.50. You put a hidden buy order for 500 shares of ABC, native to ARCA at $34.64, 200 shares at $34.63 native to NSDQ and 300 native to NYSE at $34.63. When I say native to the ECN/exchange, I mean that it will only interact with the order flow of that ECN/exchange. For instance, if someone sells 500 shares of ABC at $34.64 at NYSE, you will not get filled because your hidden order was sitting at ARCA. Hidden orders can even be traded through, meaning, you can see prints bellow the price of your buy order. This disadvantage can be countered by using what I call a hidden order “net”. You use several ECNs/exchanges that have the most volume, instead of just one. That way you have multiple order flows to interact to.
By having your orders distributed that way, when the stock drops and stops in the $34.60s area, you will avoid being used as insurance for HFTs looking to make markets. If the stock really drops quickly, say from $35 to $34.50, it won’t make much of a difference whether you are using hidden or lit (displayed) orders. It’s on the marginal situations where your orders are on the bottom or close to the bottom that hidden orders can decrease your trading costs by exposing you to less adverse selection.
With the lit orders, having the HFTs penny jump you and prevent you from getting filled at or close to the bottom can cost you significant profits as the stock reverses higher and you are forced to hit the ask in the $34.70s area. With the hidden orders, the HFTs can still game you in a similar fashion but they can do it only after they find out that there are hidden orders at a certain level. In a fast moving stock with good volume, by the time they find out, it’s too late. Your order is likely to at least have been partially filled.
In addition, HFTs don’t like hidden orders because even though they can find out that they are at a certain level, they don’t know when they get cancelled or entirely filled and the free insurance is gone. They do like to use a trick against these orders, odd lot trades. Sometimes, in order to find out if there are hidden orders in an exchange/ECN they will send out orders for a tiny amount of shares (usually less than 50). When they discover the hidden liquidity, they can penny jump it or just keep sending odd lot orders to annoy and/or increase the trading costs of the trader behind it.
Routing a Hidden Order Net
Which routes to use to best increase the change your hidden order net will capture most of the volume in a particular stock? You have to be aware of where, currently in the US, most of the volume is going through. As of September of 2014, volume is distributed as follows:
Source: BATS Exchange.
By the table, you can see that in a NASDAQ stock (Tape C), NASDAQ and ARCA do most of the volume (over 37%). For a NYSE stock (Tape A), NYSE and ARCA do most of the volume (about 31%). For AMEX stocks (Tape C), ARCA and NASDAQ do most of the volume (about 38%).
When routing your net in a NASDAQ stock, the better routes are NASDAQ (sometimes still called Island by some brokers) and ARCA as a secondary route. When trading a NYSE stock, the better routes are NYSE and ARCA. For AMEX, ARCA is the main one and NASDAQ is a secondary route."
due character limit of ET rest of the article at:
http://www.beathft.com/?p=88
Anyone agrees or disagrees with this? Any technical flaws in the article?
