PDQ's Auction1 will pause orders so it has enough time to aggregate conditional orders placed in multiple venues, including PDQ ATS, so that it can build a competitive order book. The “1” in PDQAuction1 identifies the length of time -- up to one second -- that an order is paused.
“Everybody talks about fragmentation, but no one does anything about it,” comments Keith Ross, chief executive officer of PDQ Enterprise.
The equity auction allows for the matching of orders with different latency sensitivities, thereby aggregating liquidity from a fragemented market.
The pause is not new to PDQ, which has ben working on this problem since 2009. PDQ’s ATS operates a brief pause -- 20 milliseconds or 5 milliseconds -- to allow for liquidity aggregation through an electronic algorithmic trading crowd of automated market makers competing for order flow.
[To learn more about PDQ ATS, read PDQ’s Pause & Algorithmic Trading Crowd Attains Volume Milestone.]
A longer pause has been designed into Auction1 so that during that time, passive liquidity at PDQ, algorithmic liquidity, and market making liquidity, at the choice of the client, can be aggregated into a price-time auction book.
As orders are aggregated from the PDQ ATS and other venues, this helps reverse the fragmentation of the markets, says Ross.
The idea for the product came out of discussions with institutional customers, he tells us. “What we are trying to do is just add an opportunity for larger size trades.”
Recreating the NYSE specialist
The electronic auction attempts to recreate the NYSE specialist model where a human took time to gather all the orders from the crowd at the post.
“In the good old days you used to be able to go to the post and get a look at the post. Here, the order will initiate this process of aggregating liquidity,” explains Ross, noting that Auction1 is computer driven.
“In essence we are creating an electronic specialist. He knew where the orders were.” In the old NYSE trading floor model, the specialist would make sure the broker representing a large order got a piece of the trade. “He was the traffic cop.”
In Auction1’s case, it’s all machine-based and algorithms and computers driving the aggregation and matching, but “it’s headed in the same direction as the market used to function in the 1990s,” says Ross, noting those were the “mythical good ol’ days.”
In the interview, Ross provided the following example of how Auction1 is going to work.
Say an institution is buying 5,000 shares of IBM and enters that amount in five different dark pools. The investor then has a total of 25,000 shares in the market. Various venues and brokers today are using conditional orders.
Before any one of the conditional orders in dark pools trades, Auction1 would send the message, “Are you still there?” The broker or investor then responds: “Yes, I’m still there, go ahead and trade,” or they might say, “I already bought 2,000, so trade 3,000,” for instance.
What this process will do is allocate any conditional orders that are available liquidity to Auction1, he said.
How do the conditional orders at other dark pools get to PDQ's Auction1?
The other ATSs place a copy of the conditional order at PDQ when they receive it. Since PDQ has to confirm the order with each venue, there is no risk of the order being filled without confirmation, according to the company.
Auctions vs. continuous markets
While slowing down orders would be anathema to most exchanges and dark pools, which operate continuously at lightning fast speeds, recently some academics have recommended auctions as an alternative to continuous markets.
In an academic paper published in December 2013, Eric Budish, Associate Professor of Economics at the University of Chicago Booth School of Business argues that the continuous limit order book market is a flawed design that is manifested by the high frequency trading arms race, and instead it should be replaced by frequent batch auctions -- conducted at frequent but discrete time intervals, such as every second.
One of the reasons PDQ is not defining the pause down to the last millisecond, says Ross, “is that different venues take different times to respond.” Some dark pools may respond in 100 milliseconds, while others take 50 milliseconds. Thus, while PDQ is aggregating the liquidity it doesn’t know when it’s going to get all the responses.
“It could be at the 300 millisecond or 800 millisecond [point] when we run the auction. That is why we are marketing the offering as “up to 1 second.”
Because it turns out the execution time is random -- it’s between zero and one second -- Ross says he believes the auction process will reduce gaming possibilities. Adding the random element to when an auction will actually take place adds another element of security, he feels. For example, someone might hit a bit and not find out what happened until 180 milliseconds later, which would discourage the potential for gaming by aggressive traders. “The point is if you were striving to do something nefarious, you’re going to get random response, rather than a consistent response.”
To avoid the 100- to 200-share size orders that are prevalent in many dark pools, Auction1 has raised the minimum order sizes.
PDQ will require a minimum of 2,500 shares to initiate an order and require responders -- liquidity providers -- to respond with a minimum of 500 shares orders. “We want the liquidity to be meaningful for the initiator of the auction,” says Ross.
“Auction1 creates competition among the responding orders to discover the best price for a trade, and the aggregation process allows for trades of larger size,” comments Pete Jenkins, PDQ managing director in the news release.
Ultimately, Ross says, this auction process would help consolidate the marketplace, which Ross himself finds fascinating since he comes from a high-frequency trading background at Getco. It’s a slower process, but Ross believes that will make for better and more efficient markets.Ivy is Editor-at-Large for Advanced Trading and Wall Street & Technology. Ivy is responsible for writing in-depth feature articles, daily blogs and news articles with a focus on automated trading in the capital markets. As an industry expert, Ivy has reported on a myriad ... View Full Bio