Market Microstructure Daniel Sungyeon Kim Lecture 05. Order-driven Markets Order Precedence. Q: What are order precedence rules ?. More on Order Precedence. Q: Why use any rule other than price priority ?. More on Order Precedence. Before 1997, the tick size was wide = $1/8 = 12.5 cents
Q: What are order precedence rules?
Q: Why use any rule other than price priority?
Before 1997, the tick size was wide = $1/8 = 12.5 cents
From 2001 forward, the tick size has been narrow = 1 cent
Q: Are secondary order precedence rules more important with a wide tick size or a narrow tick size?
Executive summary highlights:
Shift from “human-intermediated markets” (floor or phone) to “computer-intermediated markets” (electronic)
Rise of new trading platforms with different bus. models
Rise of high-frequency traders and algorithmic trading
Growth in trading volume
Decline in spreads and commissions
Smoothly handled the volatility and volume of the 2008 financial crisis
Cost of trading is low in the US compared to the rest of the world
What do we see?
Downward trend in spreads for most active stocks
Majority of stocks trade at a one-cent spread!
Downward trend has not been uniform for less active stocks
Shows short-lived volatility events:
2008 Financial crisis
2003 Run up to Iraq war
Spreads are partially driven by volatility
VIX is measure of volatility
Spread / VIX removes the impact of volatility
can see a downward trend once volatility is removed
What do we see here?
Doubled in the last 5 years
What has happened to commissions?
Why is the trade size dropping?
Large trades are being cut up into smaller trades to reduce the cost
More quotes per minute due to:
More volume more quote updates as depth gets depleted or replenished
Decrease in trade size: 10,000 shares desired divided into 5 orders of 2,000 shares each
Q: Why would there be a spike in number of quotes during the financial crisis?
NYSE Floor Trade = 20 seconds
NYSE Electronic Trade = 1 second
NASDAQ Telephone Trade = 10 seconds
NASDAQ Electronic Trade = 1 second
Increase in execution speed as trading shifts from floor/telephone to electronic
This refers to non-marketable limit orders [market orders or marketable limits get executed immediately, so no chance to cancel them]
New info and/or prices change Cancel your limit order and resubmit at an update price
More quotes per minute more cancels per execution
Regulation NMS in 2005 freed electronic trading platforms to compete with NYSE
It requires an exchange to reroute an order to an electronic exchange (“fast market”) that offers a better price, but the exchange can go ahead and execute a trade while ignoring a potential better price on a floor-based exchange (“slow market”)
Allows customers to choose speed over a potential better price
key that ignited massive competition by electronic exchanges
“Other” category includes internalization and dark pool trades
NASDAQ historically replied on Dealers and telephone trades
1989 added SOES to autoex on Dealers
2002 added SuperMontage which allowed autoex of market order and limit order = “matching”
2005 acquired ECNs: iNet and Brute
Q: How did Hybrid Market expand automatic execution?
Q: What do we see in Figure 2?
Q: What do we see in Figure 3?
Q: What do we see in Figure 5?