Flash trading, otherwise known as a flash order, is a marketable order sent to a market center that is not quoting the industry's best price or that cannot fill that order in its entirety. The order is then flashed to recipients of the venue's proprietary data feed to see if any of those firms wants to take the other side of the order.
This practice enables the market center to try to keep the
trade
Trade involves the transfer of goods and services from one person or entity to another, often in exchange for money. Economists refer to a system or network that allows trade as a market.
An early form of trade, barter, saw the direct excha ...
since the firm that is seeking to buy or sell shares or stock posts the information only on a specific stock exchange before sending the trade information out on the broader public markets, and making it available to all potential investors. If a deal can be struck between recipients of the flash trade, the result is a locked market with guaranteed pricing on the order. On some trades, it also results in better profits for the firms making the trades, as the firms often get rebates or lower fees for flash trades when the transaction is completed internally and doesn't get posted on rival stock exchanges. In 2009 in the United States under an exception to Rule 602 of
Regulation NMS Regulation National Market System (or Reg NMS) is a US financial regulation promulgated and described by the United States Securities and Exchange Commission (SEC) as "a series of initiatives designed to modernize and strengthen the National Market ...
flash orders were allowed.
In high-frequency trading flash orders for small amounts are utilised to find large orders so that the high frequency trader can buy or sell all available stock before the large order reaches the rest of the market. This may be done within a
dark pool
In finance, a dark pool (also black pool) is a private forum (alternative trading system or ATS) for trading securities, derivatives, and other financial instruments.Securities and Exchange Commission (SEC) by 2009 this practice had become controversial, with some market participants saying that high frequency traders could use flash orders to unfairly exploit others and that it is akin to
front running
Front running, also known as tailgating, is the prohibited practice of entering into an equity ( stock) trade, option, futures contract, derivative, or security-based swap to capitalize on advance, nonpublic knowledge of a large ("block") pend ...
.
History
According to a 2009
Bloomberg Bloomberg may refer to:
People
* Daniel J. Bloomberg (1905–1984), audio engineer
* Georgina Bloomberg (born 1983), professional equestrian
* Michael Bloomberg (born 1942), American businessman and founder of Bloomberg L.P.; politician and m ...
article:
Flash systems trace their roots as far back as 1978 to efforts by exchanges to electronically replicate how a trader might yell an order to floor brokers before entering it into the system that displays all bids and offers. Markets have evolved since the days of floor brokers’ dominance, with computer algorithms now buying and selling shares 1,000 times faster than the blink of an eye.
In 2010 flash orders gained popularity in the options markets, where as early as 2000 the
Chicago Board Options Exchange
The Chicago Board Options Exchange (CBOE), located at 433 West Van Buren Street in Chicago, is the largest U.S. options exchange with an annual trading volume of around 1.27 billion at the end of 2014. CBOE offers options on over 2,200 compani ...
(CBOE) began using the particular type of order to help improve the speed of trade executions for its clients.
In 2006,
Direct Edge
Direct Edge was a Jersey City, New Jersey-based stock exchange operating two separate platforms, EDGA Exchange and EDGX Exchange.
Beginning in March 2009, Direct Edge's market share ranged from 9% to 12% of U.S. equities trading volume, and r ...
began offering customers the ability to flash orders in the equities market. Direct Edge quickly captured market share from their rivals as their share of matched trades soared from 1% of the industry's volume to 12%. Direct Edge became a U.S. exchange in July 2010. Nasdaq and
BATS
Bats are mammals of the order Chiroptera.''cheir'', "hand" and πτερόν''pteron'', "wing". With their forelimbs adapted as wings, they are the only mammals capable of true and sustained flight. Bats are more agile in flight than most bir ...
(U.S. exchanges) created their own flash market in early 2009 in response to the Direct Edge market. Both voluntarily discontinued the practice in August 2009.
Direct Edge's response to this in 2009 was that the data that flash trading used reduced
market impact
In financial markets, market impact is the effect that a market participant has when it buys or sells an asset. It is the extent to which the buying or selling moves the price against the buyer or seller, i.e., upward when buying and downward when ...
, increased average size of executed orders, reduced trading latency, and provided additional liquidity. Direct Edge also allowed all of its subscribers to determine whether they want their orders to participate in flash trading or not so brokers have the option to opt out of flash orders on behalf of their clients if they choose to. Because market participants can choose to utilize it for additional liquidity or not participate in it at all Direct Edge believes the controversy was overstated stating:
"Misconceptions respecting flash technology have, to date, stirred a passionate but ill informed debate." Direct Edge 2009
Debate
In 2009 critics argued that the practice was harmful to market transparency. Proponents of flash trading stated that it is necessary to provide liquidity for exchanges.
Critics
In 2009 critics of the practice (notably high-frequency trading firm GETCO) contended this creates a two-tiered market in which a certain class of traders can unfairly exploit others, akin to
front running
Front running, also known as tailgating, is the prohibited practice of entering into an equity ( stock) trade, option, futures contract, derivative, or security-based swap to capitalize on advance, nonpublic knowledge of a large ("block") pend ...
. Exchanges in 2009 claimed that the procedure benefits all traders by creating more
market liquidity
In business, economics or investment, market liquidity is a market's feature whereby an individual or firm can quickly purchase or sell an asset without causing a drastic change in the asset's price. Liquidity involves the trade-off between the ...
and the opportunity for price improvement. However, a December 2009 article in The Banker noted:
in a bid to fuel the controversy and fill column space, however, several commentators and pundits have complained bitterly that flashes expose information that may allow traders to ‘front-run’ orders. The widespread perception, meanwhile, that flash orders are the preserve of hyper-sophisticated high-frequency traders has further cemented the misguided notion that the lay retail investor is in turn being cheated.
Direct Edge's response to the "two-tiered market" criticism is as follows:
First it is difficult to address concerns that may result, particularly when there is no empirical data to support such as result. Furthermore, we do not view technology that instantaneously aggregates passive and aggressive liquidity as creating a two-tier market. Rather, flash technology democratizes access to the non-displayed market and in this regard, removes different "tiers" in market access. Additionally, any subscriber of Direct Edge can be a recipient of flashed orders.
The
U.S. Securities and Exchange Commission
The U.S. Securities and Exchange Commission (SEC) is an independent agency of the United States federal government, created in the aftermath of the Wall Street Crash of 1929. The primary purpose of the SEC is to enforce the law against market ...
in September 2009 proposed banning the practice as part of regulatory reforms in the wake of the
Financial crisis of 2007–2010
Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of production, distribution, and consumption of money, assets, goods and services (the discipline of fi ...
. , the proposals have not been implemented. Even though most programs have been stopped voluntarily, it is still possible, at least with Direct Edge.''
Forbes
''Forbes'' () is an American business magazine owned by Integrated Whale Media Investments and the Forbes family. Published eight times a year, it features articles on finance, industry, investing, and marketing topics. ''Forbes'' also r ...
In 2009 Sang Lee, managing partner at Aite Group, an independent research firm in
Boston
Boston (), officially the City of Boston, is the state capital and most populous city of the Commonwealth of Massachusetts, as well as the cultural and financial center of the New England region of the United States. It is the 24th- mo ...
, saw the debate about flash orders as more
philosophical
Philosophy (from , ) is the systematized study of general and fundamental questions, such as those about existence, reason, knowledge, values, mind, and language. Such questions are often posed as problems to be studied or resolved. Some ...
than practical. Since the total market volume that goes through flash orders accounted for only 2% to 3% of daily volume in 2009, there would not be a big change in trade volume among major players if those orders disappeared.
In 2009 Bogoslaw predicted that regardless of the endgame, there would always be differences in the speed of information-technology capabilities of market centers and market participants. He argued that as long as market centers competed for order flow, investors can benefit, even if participating is only through investments in mutual or
pension funds
A pension fund, also known as a superannuation fund in some countries, is any plan, fund, or scheme which provides retirement income.
Pension funds typically have large amounts of money to invest and are the major investors in listed and priva ...
. In 2009 large institutional investors benefit directly by having enough
liquidity
Liquidity is a concept in economics involving the convertibility of assets and obligations. It can include:
* Market liquidity, the ease with which an asset can be sold
* Accounting liquidity, the ability to meet cash obligations when due
* Liq ...
to move a big block of shares with minimal price impact.