Order-type proliferation does not favour high-frequency trading (HFT), despite buy-side perceptions, according to research by consultancy Rosenblatt Securities.
While there is a common perception that exchanges now offer thousands of order types, Rosenblatt’s research found that US exchanges currently offer 252. Furthermore, when removing similar versions of the same order type across exchanges there are just 36 unique order types in use.
Rosenblatt’s report also found that, while buy-side investors were often concerned that HFT firms had access to market order types that they did not, this was rarely the case.
In general, HFT firms will only have access to order types that are unavailable to the buy-side if they are registered market makers, in particular they have recourse to peg orders designed to ensure compliance with Securities and Exchange Commission rules.
However, the usefulness of these in providing HFTs firms with a major advantage is debatable.
“The design of these orders is somewhat cynical as they peg the market maker’s bid or offer as far away from the national best bid and offer (NBBO) as possible without violating the ‘no stub quote rule.’ Cynical though they may be from a compliance perspective, they don’t provide HFT market makers with any tangible advantages over ordinary investors,” the report said.
Aside from HFT firms, Rosenblatt found the only other major issue regarding unequal order type access was from retail orders, with retail investors being able to access numerous opportunities that are denied to institutional investors. However, these opportunities would not usually be available to institutional investors anyway, according to Rosenblatt, and market makers don’t compete for their order flow in the same way as they do for retail orders.
The key advantage that HFT firms gain stems primarily from their knowledge of order types and understanding of market structure, which are also available to any buy-side institution that invests the time to comprehend them.
“Our general view on market structure and the buy-side is that more understanding is better,” the report said.
“The good news is, those traders who are willing to invest the time will find the exchange community more than willing to help, and committed to improving disclosure.”