Flash Trading

Flash Boys

Flash crash

Flash trading, otherwise known as a flash order, is defined by industry trade publication ‘Traders Magazine’ as ‘a marketable order sent to a market center that is not quoting the industry’s best price or that cannot fill that order in its entirety. The order is then flashed to recipients of the venue’s proprietary data feed to see if any of those firms wants to take the other side of the order. This practice enables the market center to try to keep the trade.’ Under an exception to Rule 602 of Regulation NMS, flash orders are currently legal.

Bloomberg states: ‘Flash systems trace their roots as far back as 1978 to efforts by exchanges to electronically replicate how a trader might yell an order to floor brokers before entering it into the system that displays all bids and offers. Markets have evolved since the days of floor brokers’ dominance, with computer algorithms now buying and selling shares 1,000 times faster than the blink of an eye.’

More recently flash orders gained popularity in the options markets, where since as early as 2000 the Chicago Board Options Exchange (CBOE) began using the particular type of order to help improve the speed of trade executions for its clients. In 2006, Direct Edge began offering customers the ability to flash orders in the equities market. Direct Edge became a U.S. exchange in 2010. NASDAQ and BATS (U.S. exchanges) created their own flash market in early 2009 in response to the Direct Edge market. Both voluntarily discontinued the practice several months later.

Direct Edge’s claims that flash trading reduces market impact, increases average size of executed orders, reduces trading latency, and provides additional liquidity. Direct Edge also allows all of its subscribers to determine whether they want their orders to participate in flash trading or not so brokers have the option to opt-out of flash orders on behalf of their clients if they choose to. Because market participants can choose to utilize it for additional liquidity or not participate in it at all Direct Edge believes the controversy is overstated stating: ‘Misconceptions respecting flash technology have, to date, stirred a passionate but ill informed debate.’

Critics of the practice contend this creates a two-tiered market in which a certain class of traders can unfairly exploit others, akin to front running (the illegal practice of a broker executing orders on a security for its own account while taking advantage of advance knowledge of pending orders from its customers). Exchanges claim that the procedure benefits all traders by creating more market liquidity and the opportunity for price improvement. However, a December 2009 article in ‘The Banker’ noted: ‘in a bid to fuel the controversy and fill column space, however, several commentators and pundits have complained bitterly that flashes expose information that may allow traders to ‘front-run’ orders. The widespread perception, meanwhile, that flash orders are the preserve of hyper-sophisticated high-frequency traders has further cemented the misguided notion that the lay retail investor is in turn being cheated.’

Direct Edge responded to claims of a fostering a ”two-tiered market’ by stating, ‘First it is difficult to address concerns that may result, particularly when there is no empirical data to support such as result. Furthermore, we do not view technology that instantaneously aggregates passive and aggressive liquidity as creating a two-tier market. Rather, flash technology democratizes access to the non-displayed market and in this regard, removes different ‘tiers’ in market access. Additionally, any subscriber of Direct Edge can be a recipient of flashed orders.’

The Securities and Exchange Commission in September 2009 proposed banning the practice as part of regulatory reforms in the wake of the Financial crisis of 2007–2010. As of May 2010, the proposals have not been implemented. Even though most programs have been stopped voluntarily, it is still possible, at least with Direct Edge.

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