Themis Trading, an independent institutional agency brokerage specializing in equities, launched an explosive charge at Nasdaq OMX Friday, suggesting that the exchange operator's new pricing incentives are giving high-frequency traders an unfair edge.
The firm contends those incentives were also the cause of the excessive spam that plagued a number of stocks on Nov. 1, the second session after Hurricane Sandy brought trading in the U.S. to a standstill for two days. Citing research by Nanex, Themis pointed out that on Nov. 1, there were 369 seconds in which the number of quotes in Bank of America (BAC) stock exceeded 17,000; a total of 6.6 million quotes. During those seconds, only 1,879 actual trades were executed, Themis said.
Now even though BAC shares trade on the New York Stock Exchange, Themis said all of this quote spam came from Nasdaq, a finding that Nanex breaks down here.
The numbers are just as staggering when examining BAC shares between the market's opening on Nov. 1 and 12:45 p.m. Themis noted during that period, BAC was quoted 7.8 million times on just 116,000 trades. The company also revealed that this scenario was played out in the Nasdaq stocks Yahoo and Sirius XM Radio.
Themis believes it has the answer to what caused this, pointing its finger at Nasdaq's NBBO Setter Pricing and Qualified Market Maker (QMM) programs. The company said that both of these programs are designed to provide additional rebates for clients who are first to set the NBBO or just the NASDAQ best bid or offer. These additional rebates can range from $0.0002/share to $0.0005/share, which Themis argues is a lot of money in the HFT world.
Putting two and two together, we believe that all the intense order submission and cancellation by market-making HFT firms was a race to set the NBBO quote first. New algorithms have been written and deployed by large HFT firms to do everything they can to get to the top of the book FIRST, and set that NBBO. These algorithms are doing this in names that are already hyper-liquid; remember that HFT "market-making" firms are trying to be 1st in line to get a rebate, but only in names in which ample liquidity exists at the same price behind them.
Margins have become razor thin the HFT industry. Their profits have shrunk alongside general market volumes; a 10% increase in profits for large speed-of-light pick-up-the-rebate video gaming HFT firms is a large carrot to be offered up by a stock exchange like NASDAQ for sure! Volumes and profits are also hurting at the stock exchanges as well, which is why NASDAQ, in their quest to maximize short-term profits, would introduce such programs as outlined above.
Themis says this ultimately amounts to Nasdaq stressing the entire trading ecosystem for the sake of not only its own short-term bottom line, but also for the benefit of its largest HFT customers.
Nasdaq rebuts these charges."QMM is specifically designed for market makers to enhance price discovery across a wide spectrum of stocks by providing both incentives and obligations such as the requirement to quote in 1,000 securities which must be on the NBBO 25% of the trading day," spokesman said in an email.
"To qualify for the program, member firms must also abide by the excessive messaging policy in place only at NASDAQ and of course market maker rules prohibiting quote stuffing."
As for the message volumes, the spokesman said the impact of the additional quote traffic has been modest. "As our systems are designed to handle message volumes with minimal throughput degradation, we're seeing member firms submit marketable orders in active securities and we've received feedback that the impact of additional quote traffic at the NBBO is modest as member firms have also already prepared to handle any active periods of messaging volumes," the spokesman wrote.