Assiduous Reader DR alerts me to the Financial Post’s Barry Critchley’s attempt to whip up more hysteria regarding the so-called evils of so-called High Frequency Trading:
At best it may be unintentional consequences. At worst it may be an attempt to encourage high frequency trading in the preferred share market – all of which acts to the detriment of retail investors.
Diane Stibbard and Keith Honeyborne are two retail investors who make part of their living by buying, owning and selling preferred shares – and have concerns about how trades, especially at the market open, occur in that market.
…
Stibbard, an experienced investor, details the means by which the HFTs queue jump. That process starts with a market order from a retail investor – meaning the buyer or seller doesn’t specify a price – that in turn elicits a response from more sophisticated retail investors. The latter group then puts in a limit order that is inside (or between) the bid and ask of the market order. In turn, other more sophisticated retail investors follow which reduces the bid/ask spread.Then the HFTs pounce. “At approximately one second before the open, a HFT will enter a market order on the ask side for a number of shares slightly lower than the market bid quantity, which because of your [TMX] Rule 4-701, will enable it to queue jump ahead of the prior limit orders,” said Stibbard.
The result of this last-second involvement, Stibbard says, is that at the market open, “the limit price of the lowest ask is used as the clearing price. As a result, the orders of the selling retail investors become the stalking horse for the HFT but that price-setting investor’s order will never be filled.”
At the heart of the matter is Rule 4-701:
Rule 4-701 Execution of Trades at the Opening
(1) Subject to Rule 4-702, securities shall open for trading at the opening time, and any opening trades shall be at the calculated opening price.
Amended (February 24, 2012)
(2) The following orders shall be completely filled at the opening:
(a) market orders and better-priced limit orders; and(b) MBF orders.
(c) Repealed (October 15, 2012)
(d) Repealed (October 15, 2012)
Amended (October 15, 2012)
(3) The following orders are eligible to participate in the opening but are not guaranteed to be filled:
(a) Repealed (August 7, 2001)(b) limit orders at the opening price.
(c) Repealed (October 15, 2012)
Amended (October 15, 2012)
(4) Unless otherwise provided, trades shall be allocated among orders at the opening price in the following manner and sequence:
(a) trades shall be allocated to orders guaranteed a fill pursuant to Rule 4-701(2) then;(b) all possible crosses shall be executed; then
(c) Repealed (August 7, 2001)
(d) to limit orders at the opening price according to time priority.
(5) Repealed (August 7, 2001)
(6) Repealed (August 7, 2001)
(7) Orders at the opening price that are not completely filled at the opening shall remain in the Book, at the opening price.
So my reaction is, in short: Boo-hoo-fucken-hoo.
It is a pity that Critchley did not see fit to publish the “three-page letter” that Stibbard wrote to the Exchange, or to suggest improvements in the rule, but let’s look at the situation more closely.
Firstly, the strategy at issue starts with somebody entering a market order for delayed-execution in a size that is large relative to the usual or expected opening trades (which we may assume, in this market, is a very small number!). Or, to put it bluntly, we need to start the process with a moron.
Stibbard and Honeyborne like to make a little money fleecing morons – nothing wrong with that, that’s why God created morons. So, fine: they take the opposite side of the market with a limit order inside the other limit orders that are in the book at that point – which, no doubt, will fuel a column next week dealing with the complaints of those poor souls who entered their limit orders at 9:15, who are being victimized by predatory trading by the current complainants, who are not-quite-high-but-gee-whiz-pretty-often-you-know frequency traders.
Remember the old adage?
Big fleas have little fleas
On their backs to bite ’em
And them fleas got smaller fleas
And so ad infinitum.
So the predatory Stibbard and Honeyborne are having their lunch eaten by more predatory predators. And so they complain that the rules are unfair, that there should be special rules that will allow them to compete with the big boys, even though they’re conducting their predatory trading by typing orders manually on their ten-bucks-a-throw discount brokers’ screens. Which, boys and girls, is the whole story of the HFT controversy in a nutshell.
Still, it would be interesting to learn just what they propose as a solution. Eliminate the priority of market orders over limit orders? Have a black-out period before the opening, during which market orders will be refused? Criminalize the possession and use of better algorithms and hardware than what they have? Maybe the Exchange should simply deposit money directly into their bank account?
It will also be noted that there is no reason to believe that the fiercer predators are, in fact, HFT. I don’t think HFT will be much interested in the preferred share market, where 40,000 shares in a day will get you on the PrefBlog volume highlights; and besides, I don’t think any preferred share issues are qualified for maker-taker exchange fees, which is a big chunk of HFT profits; and anyway, I don’t know how maker-taker pricing applies to a collision of market orders at the opening and am too lazy to look it up. It’s more likely a prop trader or market-maker at a brokerage, who can get away with using yesterday’s technology because the competition is using last week’s. There is a strong possibility, as discussed below, that it isn’t a professional at all, that it’s just another retail trader committing the unpardonable sin of using a brokerage that isn’t bank-owned, one that offers order types that the Powers That Be have deemed too complex for stupid Canadians. How awful of him!
How would I attempt to compete in this kind of big boy’s game? Interactive Brokers offers iceberg orders, which:
provides a way to submit large volume orders to the market in increments while publicly displaying only a specified portion of the total order size.
These are supported for entry on the Toronto Exchange. And on the Toronto Exchange:
10. How will Icebergs be treated at the opening?
The total volume of an Iceberg order will be included in the calculation of the Calculated Opening Price (COP). If an Iceberg order is a Better Priced Limit order (BPL) or a MKT order, the disclosed volume is guaranteed a fill at the Opening. The reserve volume is not guaranteed to be filled, but will be treated as a Participatory Order for the opening rotation. Any remaining reserve volume will be re-priced at the COP.
So say there’s a market buy order coming in for 5,000 shares. And, say, by looking at the Level 2 book at 9:28 am, you figure the opening price is going to be 24.95, and you’d love to sell a bunch at anywhere north of 24.90.
Well, what you do is you enter your order to sell a bunch at 24.93, but display only 100 shares. So the sharpie with the market order, ignoring your order because it’s so small, figures he’s going to be filled at 24.95, but he’s only going to get 24.93. He’ll still get filled before you do, but the uncertainty is going to make the deal a little less attractive for him.
[To be frank, I’m not completely sure that this will work as planned. I’m not sure precisely what information is visible to clients in the pre-opening. Better check carefully before entering your order!]
And, as a side-benefit, the moron with the initial market order will get a better price, which is the whole point of the rules in the first place. It will be noted that the moron with the initial market order will never, ever get a worse price in the presence of the so-called predatory order than he will in its absence, and will probably get a better one (although you can make an argument that enough of this so-called predation will discourage the entry of limit orders before the open. Let’s see some figures on that first, though). It will also be noted that this entire dispute concerns traders and has nothing to do with investing which are two very different games. As I have often asserted in the past, market microstructure should be evaluated solely on the basis of how it affects investors – traders can look after themselves.
Another strategy, which will cost money but might be worth it in the end, is to create still more uncertainty by entering a market order for 300 shares at the last second. If this works, you might get an unfortunate fill if this small size tips the balance so that the opening is executed on the bid side rather than the ask … and the sharpie with his market order of 4,900 shares isn’t going to like that at all, perhaps to the extent he gives up his (rather simplistic) strategy. You could also do this at Interactive Brokers with their Good After Time order, which according to their example will give time increments down to 1-second. So presumably, you could put in this market order at 9:29:00, with a Good After Time of 9:29:59, although I’ve never tried it and don’t know if the IB system will actually do this. If it does, and if the “approximately one second before opening” estimate of Ms. Stibbard is correct, then there’s a decent chance that Stibbard and Honeyborne are being predated by somebody who’s only one notch up the food chain, not an apex predator. An apex predator would measure the interval between order placement and market opening in milliseconds, and not many of them either.
Note that Canadian banks’ discount brokerages do not – as far as I know – offer these useful order types to retail scum because … they don’t have to! Ha-ha! Suckers!
However, there is a third way to play this new game, and that’s to enter your own pre-emptive market order to sell. It’s 9:20, there’s a market buy order for 5,000 shares and you’ve got your limit sell order for 4,000 shares at 24.90, which you think will set the opening price. Maybe it’s an iceberg, maybe it’s not, whatever. But you’re afraid the competition is going to come in at 9:29, nine minutes from now, with a market order to sell 4,500 and scoop up all the profits. Fine. Get there first. Put it your own market sell order for 4,500 (in addition to your limit order). Now, if the enemy puts in his own market order, he’s going to tip the balance and the opening will be on the bid side, which would be horrible – so, you reason, he probably won’t do it. And hurray, you scoop the entire market buy!
It gets interesting, of course, if the enemy also reads PrefBlog and has been carefully watching the issue in question, because the pattern of orders will make it clear to him just what’s happening. ‘Oh, yeah, tough guy?’ he’ll think to himself, ‘You wanna play cute with me? Eat this!’ as he puts in a market sell for 4,500. And now it’s a fascinating Mexican stand-off, that is very well modelled as a Prisoner’s Dilemma game:
- If you both execute, you both lose a lot of money
- If one party cancels, he’s flat and the executing party makes a lot of money
- If you both cancel, you’re both flat, and somebody else grabs the moron’s cash
Note that there was such a thing as an anti-scooping rule so pro accounts couldn’t play this game after 9:28, but these rules have been repealed. Note also that I am not a trading specialist and rarely, if ever, trade at the opening. Or the close, for that matter. Plain vanilla trading works just fine for me.
In more traditional news, real estate prices rose faster than debt:
Statistics Canada’s quarterly national balance sheet report said household credit debt (consumer credit, mortgages and other loans) rose by 1.3 per cent in the quarter, outpacing the growth in disposable income. As a result, the ratio of credit debt to disposable income, a closely watched measure of the household debt burden, rose to 163.6 per cent, slightly below the record 164.1 per cent in the third quarter of 2013.
However, household net worth rose by 2.3 per cent in the second quarter, to a record $8.1-trillion (or $227,000 per person), driven primarily by a continued rise in real estate values. As a result, the ratio of household credit market debt to net worth – another measure of consumers’ capacity for debt – fell to 22.3 per cent from 22.5 per cent, the lowest level in six years.
The rise in household consumer credit came from all sources – mortgages, non-mortgage loans and consumer credit (primarily credit cards). Consumer credit rose 1.4 per cent in the quarter, its biggest increase since the 2012 third quarter. Mortgage debt rose 1.4 per cent, its biggest rise in three quarters.
It was a poor day for the Canadian preferred share market, with PerpetualDiscounts losing 24bp, FixedResets down 21bp and DeemedRetractibles off 15bp. Volatility was average. Volume was low.
And now it’s time for PrefLetter!
| HIMIPref™ Preferred Indices These values reflect the December 2008 revision of the HIMIPref™ Indices Values are provisional and are finalized monthly |
|||||||
| Index | Mean Current Yield (at bid) |
Median YTW |
Median Average Trading Value |
Median Mod Dur (YTW) |
Issues | Day’s Perf. | Index Value |
| Ratchet | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.5244 % | 2,647.0 |
| FixedFloater | 4.14 % | 3.40 % | 25,692 | 18.56 | 1 | 0.0436 % | 4,185.8 |
| Floater | 2.91 % | 3.03 % | 46,759 | 19.66 | 4 | -0.5244 % | 2,737.2 |
| OpRet | 4.05 % | 0.22 % | 93,077 | 0.08 | 1 | -0.1578 % | 2,727.1 |
| SplitShare | 4.28 % | 3.73 % | 111,959 | 3.93 | 5 | -0.0036 % | 3,155.4 |
| Interest-Bearing | 0.00 % | 0.00 % | 0 | 0.00 | 0 | -0.1578 % | 2,493.7 |
| Perpetual-Premium | 5.46 % | 0.43 % | 71,673 | 0.09 | 20 | -0.0530 % | 2,440.0 |
| Perpetual-Discount | 5.23 % | 5.14 % | 106,577 | 15.19 | 16 | -0.2382 % | 2,608.5 |
| FixedReset | 4.26 % | 3.81 % | 181,959 | 6.58 | 74 | -0.2101 % | 2,559.5 |
| Deemed-Retractible | 5.00 % | 1.87 % | 103,420 | 0.20 | 42 | -0.1509 % | 2,564.9 |
| FloatingReset | 2.62 % | 0.48 % | 82,022 | 0.08 | 6 | -0.1504 % | 2,528.5 |
| Performance Highlights | |||
| Issue | Index | Change | Notes |
| FTS.PR.J | Perpetual-Discount | -2.36 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2044-09-12 Maturity Price : 23.27 Evaluated at bid price : 23.61 Bid-YTW : 5.05 % |
| PWF.PR.A | Floater | -1.73 % | YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2044-09-12 Maturity Price : 20.50 Evaluated at bid price : 20.50 Bid-YTW : 2.57 % |
| IFC.PR.A | FixedReset | -1.01 % | YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.60 Bid-YTW : 4.38 % |
| VNR.PR.A | FixedReset | 1.03 % | YTW SCENARIO Maturity Type : Call Maturity Date : 2017-10-15 Maturity Price : 25.00 Evaluated at bid price : 25.51 Bid-YTW : 3.91 % |
| Volume Highlights | |||
| Issue | Index | Shares Traded |
Notes |
| ENB.PF.E | FixedReset | 111,630 | Nesbitt crossed three blocks: 11,200 shares, 14,400 and 50,000, all at 25.05. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2044-09-12 Maturity Price : 23.14 Evaluated at bid price : 25.05 Bid-YTW : 4.29 % |
| TD.PF.A | FixedReset | 61,430 | Desjardins crossed 50,000 at 25.30. YTW SCENARIO Maturity Type : Limit Maturity Maturity Date : 2044-09-12 Maturity Price : 23.25 Evaluated at bid price : 25.30 Bid-YTW : 3.81 % |
| BNS.PR.Y | FixedReset | 46,370 | TD crossed 40,000 at 24.00. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2022-01-31 Maturity Price : 25.00 Evaluated at bid price : 23.97 Bid-YTW : 3.51 % |
| RY.PR.D | Deemed-Retractible | 38,953 | RBC crossed 35,000 at 25.60. YTW SCENARIO Maturity Type : Call Maturity Date : 2015-02-24 Maturity Price : 25.25 Evaluated at bid price : 25.60 Bid-YTW : 1.87 % |
| CM.PR.O | FixedReset | 36,300 | RBC crossed 25,000 at 25.38. YTW SCENARIO Maturity Type : Call Maturity Date : 2019-07-31 Maturity Price : 25.00 Evaluated at bid price : 25.36 Bid-YTW : 3.83 % |
| SLF.PR.D | Deemed-Retractible | 32,207 | RBC crossed 25,000 at 22.45. YTW SCENARIO Maturity Type : Hard Maturity Maturity Date : 2025-01-31 Maturity Price : 25.00 Evaluated at bid price : 22.39 Bid-YTW : 5.81 % |
| There were 16 other index-included issues trading in excess of 10,000 shares. | |||
| Wide Spread Highlights | ||
| Issue | Index | Quote Data and Yield Notes |
| FTS.PR.J | Perpetual-Discount | Quote: 23.61 – 24.08 Spot Rate : 0.4700 Average : 0.3073 YTW SCENARIO |
| BAM.PR.X | FixedReset | Quote: 22.16 – 22.45 Spot Rate : 0.2900 Average : 0.1968 YTW SCENARIO |
| BNS.PR.R | FixedReset | Quote: 25.72 – 25.95 Spot Rate : 0.2300 Average : 0.1382 YTW SCENARIO |
| RY.PR.B | Deemed-Retractible | Quote: 25.50 – 25.70 Spot Rate : 0.2000 Average : 0.1285 YTW SCENARIO |
| ELF.PR.G | Perpetual-Discount | Quote: 22.18 – 22.36 Spot Rate : 0.1800 Average : 0.1129 YTW SCENARIO |
| PWF.PR.A | Floater | Quote: 20.50 – 20.86 Spot Rate : 0.3600 Average : 0.2945 YTW SCENARIO |