Complex orders (Chapter 13)

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Securities Trading: Principles and Procedures Complex orders (Chapter 13) 2018, Joel Hasbrouck, All rights reserved 1 Order types Basic orders: simple market and limit Qualified orders: IOC, FOK,

1 Securities Trading: Principles and Procedures Complex orders (Chapter 13) 2018, Joel Hasbrouck, All rights reserved 1 Order types Basic orders: simple market and limit Qualified orders: IOC, FOK, AON, hidden Complex orders are reactive. Might be automatically entered, modified, and cancelled in reaction to market events. Key types: stop, pegged, discretionary, reserve. Documentation and examples BATS: Our markets U.S. Stock Exchanges CBOE order type guide (under Quick Links ) The BATS order type guide has animated examples, indicated as (B) Interactive Brokers: Trading Order Types and Algos The IB guide is comprehensive. 2018, Joel Hasbrouck, All rights reserved 2 1

2 The spectrum Basic orders Algorithms Simple, reliable, predictable Complicated, misfire and misbehave, unpredictable 2018, Joel Hasbrouck, All rights reserved 3 Floor markets: held and not held orders Basic orders: broker held responsible for mishandling. Buy 100 MSFT at the market doesn t execute. Buy 100 MSFT limit 30 misses the market. But a customer could say, Buy 5,000 MSFT over the day. Use your judgement about how and when to trade. Best effort Not held Complex orders/algos are like floor markets not-held orders. 2018, Joel Hasbrouck, All rights reserved 4 2

3 Stop order (B) Suppose MSFT is trading around $27 per share. A stop-sell (stop-loss) order: Sell 100 sh MSFT, stop 25 If MSFT trades at 25 or lower, enter an order to sell 100. A trade at 25 or lower activates or elects the order. Stop price limit price. Consider: Sell 100 sh MSFT, limit 25 A stop order can t go right into the limit order book It is not available for execution. It is placed in a special file or queue, like an all-or-nothing (AON). Once it is activated (elected), it enters the book, and becomes available for execution. A stop-buy order: Buy 100 sh MSFT, stop 30. If MSFT trades at 30 or higher, enter an order to buy , Joel Hasbrouck, All rights reserved 5 Uses Used to protect accumulated gains. I bought ABC at 15; it s now at 30. If it drops below 25 I want to sell. Used as a safety measure for margined positions. I bought XYZ at 32 on margin [with borrowed money]. If it drops to 31 or more, I want out. Stop-buy orders are used as safety measures on short margined positions. I sold DEF short at 49. If the price rises above 53, I want to cover [buy the stock back] to prevent any further losses. 2018, Joel Hasbrouck, All rights reserved 6 3

4 The stop price is a trigger price, not a guarantee Sell 300 sh MSFT, stop 25 If there is a trade in MSFT at 25 or lower, enter a market order to sell. Bids Shares Price Stop-loss orders Shares Stop price , Suppose that a new order arrives, Sell 100 shares, limit 25. The order executes against the bid in the book, at 25. The stop order is elected and trades at , Joel Hasbrouck, All rights reserved 7 Stop-limit orders Stop orders are generally understood to be market orders. Once they are elected, they are executed at the best available price. This price might be much worse that the trader intended. Stop-limit orders carry limit prices. They won t execute worse than the limit price, but they might not execute. In the last example, Sell 300 sh MSFT, stop 25, limit 24, would not execute. It would be added to the book, on the ask side. 2018, Joel Hasbrouck, All rights reserved 8 4

6 Stop orders and price dynamics Bids Shares Price Stop-loss orders Shares Stop price , An order arrives: Sell 10 shares, limit What happens? 2018, Joel Hasbrouck, All rights reserved 11 Who s responsible for handling a stop order? In late 2015, NASDAQ and the NYSE said that they would stop accepting stop orders. Stop order functionality is still available. A broker can simulate the strategy by monitoring trades and submitting a market or limit order when indicated. 2018, Joel Hasbrouck, All rights reserved 12 6

7 Recent experience in FX markets FCA fines five banks 1.1 billion for FX failings and announces industry-wide remediation programme Press release from UK Financial Conduct Authority (12/11/2014) Traders at different Banks formed tight knit groups in which information was shared about client activity These groups were described as, for example, the players, the 3 musketeers, 1 team, 1 dream, a co-operative and the A-team. Traders shared the information obtained through these groups to help them work out their trading strategies. They then attempted to manipulate fix rates and trigger client stop loss orders (which are designed to limit the losses a client could face if exposed to adverse currency rate movements Gunning the stops : triggering customer stop orders on purpose. 2018, Joel Hasbrouck, All rights reserved 13 The trailing stop order The stop price adjusts (in one direction) to the market price. Sell 100 sh XYZ, stop price trailing by $4 If the last sale price is $80 when the order is entered, the stop price is $76. Whenever the last sale price moves up (from the previous sale), the stop price is reset. If 80 is followed by 81, the stop price is reset to 77. If the last sale price drops, the stop price is not reset. A sequence 80, 82, 79 leaves the stop price at , Joel Hasbrouck, All rights reserved 14 7

8 Pegged orders (B) Limit orders that are automatically priced and repriced. A primary peg refers to the same side of the market. Buy 1,000 MSFT pegged to the NBB The initial price of the order is the NBB. If the NBB changes, the price of the order changes with it. Sell 1,000 MSFT pegged to the NBO The initial price of the order is the NBO. 2018, Joel Hasbrouck, All rights reserved 15 Non-aggressive offsets for primary peg orders An offset is the distance from the same-side quote. A non-aggressive offset moves the limit price behind the quote. Example: the NBB in MSFT is currently $50. I submit, buy MSFT, primary peg, with a $0.02 non-aggressive offset. My order is initially priced at $ If the NBB drops to $49.99, my order is repriced to $ It might execute, if an incoming sell order executes at multiple prices. A primary peg sell order with a non-aggressive offset is priced above the NBO 2018, Joel Hasbrouck, All rights reserved 16 8

9 Visibility of pegged orders A primary peg order might be displayed or nondisplayed. If nondisplayed (hidden), we can specify an aggressive discretionary offset. Suppose NBBO in ABC is $10.00 bid, offered at $ Buy with a primary peg, and an aggressive offset of $0.03 is initially priced at $ Could we have a displayed aggressive primary peg? 2018, Joel Hasbrouck, All rights reserved 17 Market and midpoint pegs A market peg is set relative to the opposite side quote. Suppose NBBO in ABC is $10.00 bid, offered at $ Buy ABC, market peg with a $0.02 (non-aggressive) offset is initially priced at $ Market pegs are generally hidden. Could we have a market peg with an aggressive offset? Midpoint pegs are pegged to the midpoint of the NBBO. 2018, Joel Hasbrouck, All rights reserved 18 9

10 Example: primary peg with offset The book is Eve enters Buy 5,000 with a $0.01 nonaggressive offset. Trader Quantity Price Sell Fiona Buy Akari Brian Cam , Joel Hasbrouck, All rights reserved 19 Trader Quantity Price Sell Fiona Buy Akari Brian Eve 5, Cam Hari: Buy 150, limit Trader Quantity Price Sell Fiona Buy Hari Akari Eve 5, Brian Cam , Joel Hasbrouck, All rights reserved 20 10

11 Trader Quantity Price Sell Fiona Buy Akari Brian Eve 5, Cam Alternatively: A 100-share sell order executes against Akari Trader Quantity Price Sell Fiona Buy Brian Cam Eve 5, , Joel Hasbrouck, All rights reserved 21 Trader Quantity Price Sell Fiona Buy Brian Cam Eve 5, and another order executes against Brian. Trader Quantity Price Sell Fiona Buy Cam Eve 5, , Joel Hasbrouck, All rights reserved 22 11

12 Sell orders arrive and execute the NBB Eve s bid Eve s order always moves away from the bid. It is never at the bid. Orders like this are rarely hit. Does she really want to buy? 2018, Joel Hasbrouck, All rights reserved 23 Change the situation slightly Suppose the book is (Eve already has a sell order on the book.) Trader Quantity Price Fiona Sell Eve Eve: Buy 5,000, primary peg, $0.01 non-aggressive offset. Buy Akari Brian Cam , Joel Hasbrouck, All rights reserved 24 12

Trader Quantity Price Fiona 400 10.08 Sell Eve 200 10.

Discretionary orders (B) Start passive; might go active. Example: The NBBO in MSFT is 29.80 bid, offered at 29.90. Buy 100 MSFT limit 29.79 with an aggressive discretionary offset of 0.

14 Discretionary orders (B) Start passive; might go active. Example: The NBBO in MSFT is bid, offered at Buy 100 MSFT limit with an aggressive discretionary offset of 0.05 If the NBO drops to = or below, the order is repriced to 29.84, and executes against the NBO. The execution price is the NBO (not the limit price of the order). Discretionary orders are often (primary) pegged. Next: the formal analysis of a pegged discretionary buy order. 2018, Joel Hasbrouck, All rights reserved 27 NBO I m a discretionary order pegged to the NBB NBB 2018, Joel Hasbrouck, All rights reserved 28 14

Iceberg orders (B) 2018, Joel Hasbrouck, All rights reserved 29 Reserve ( iceberg ) orders Only a part of the size is visible. The rest is hidden reserve.

15 Iceberg orders (B) 2018, Joel Hasbrouck, All rights reserved 29 Reserve ( iceberg ) orders Only a part of the size is visible. The rest is hidden reserve. When the visible portion executes, it is replenished from the reserve. This avoids showing the full size of the order all at once. If the refresh is instantaneous, the order is easy to detect. Randomization (of time or refresh quantity) will help to conceal the order. 2018, Joel Hasbrouck, All rights reserved 30 15

16 Implementation Where is the logic (hardware/software) for the order implemented? Possibilities: Customer/trader Broker Exchange 2018, Joel Hasbrouck, All rights reserved 31 The life cycle Advanced algos are usually developed by proprietary ( prop ) traders and implemented on traders systems. Next, they re offered by technologically sophisticated institutional brokers then retail brokers Finally they become standard order types on exchanges. 2018, Joel Hasbrouck, All rights reserved 32 16

17 The advantages of implementation on exchanges. The algo doesn t have to be coded as many times (once per exchange) The hardware is at each exchange (less subject to delays). The algo is more stable. But some algos are best implemented by the broker. An all-or-nothing order is handled by scanning the sizes available at all exchanges, and then (if the requested amount is available) routing separate orders to each exchange. 2018, Joel Hasbrouck, All rights reserved 33 Current trends in order type and design. Traditionally, exchanges have competed to offer complex order types. Recently, NYSE Arca (owned by ICE) has eliminated some order types, like stop orders. Some order types appear designed to favor certain groups of traders. Hide Don t Slide orders believed to favor high-frequency traders. Post-only orders only available to designated market makers. An exchange s introduction or a new order type, elimination of an existing type, or modifications must be approved by the SEC. 2018, Joel Hasbrouck, All rights reserved 34 17

Conditional and complex orders

Conditional and complex orders Securities Trading: Principles and Procedures Chapter 12 Algorithms (Algos) Less complex More complex Qualified orders IOC, FOK, etc. Conditional orders Stop, pegged, discretionary,