Sep 18, 2011

Nasdaq Velocity and Forces is the New Level II

Written by Katie Gomez

Maybe I’ve been in this business too long. There was a time when level II was revolutionary. Even in the early 90’s only a few people had it, and they had a huge advantage over people who didn’t. When I was learning to trade in 1994 we would watch level II data and try to follow GSCO and MSCO and MLCO and HRZG and JEFF. In those days Market Makers had to be good for 1000 shares on the best bid and best offer. You could see bidders coming in and offers stacking up and take advantage. In 1997 ECN’s like ISLD and INET got in the game and the advantages started to fade.

Before Trade Ideas, in what we now call the $50 Million Dollar Education (Thanks Menlo Ventures) we were building a trading platform to compete with REDI Plus. I visited a lot of potential customers. By this time everyone knew what level II looked like. Two of the most popular customer questions were

1) How can I see it?
2) How can I hide my orders so they don’t show up?

Please take a second to think about those two questions together. Everyone thought they were the first to use this tool, when the tool was in fact already well established. If you’re new to it, and you can figure out how to fake it, then what makes you think any of it is real? Below is from one of our market data feeds.

The chart below shows how many quotes it takes to get $10,000 worth of stock traded in the U.S. for any point in time during the trading day over the last 4 years. Higher numbers indicate a less efficient market: it takes more information to transact the same dollar volume of trading. Quote traffic, like spam, is virtually free for the sender, but not free to the recipient. The cost of storing, transmitting and analyzing data increases at a higher rate than its rate of growth: that is, a doubling of data will cost significantly more than twice as much.

This explosion of quote traffic relative to its economic value is accelerating. Data for September 13, 2011 is the thicker red line that snakes near the high. There is simply no justification for the quote traffic that underlies this growth. Only the computers generating this traffic benefit when they successfully trick other computers or humans into revealing information, or executing trades. This is not progress. Progress is almost always accompanied by an acceleration in efficiencies. This is completely backwards.

And to anyone who might say: “To my knowledge there’s been no proof shown that high-frequency trading has been detrimental.”, we’d like to submit this as exhibit A. We think that a 10-fold increase in cost would be considered “detrimental” by most business people.

And that’s just what’s on the surface. I’ve read multiple articles like this. There’s just a tremendous amount of traffic out there with no obvious value. The number of quotes keep increasing as the value decreases.

The article suggests malice and fraud are behind the explosion in bandwidth. My experience in technology suggest something far more banal. There is a saying a fool with good intentions is more dangerous than an enemy. How many people wanted a piece of high frequency trading but didn’t really know how to get there? They hire a cheap, inexperienced programmer, and they produce a lot of activity. But they aren’t really doing a good job. How else do you explain all of those quotes that are pegged to exactly 50¢ from the best bid or offer? What good could really come from constantly updating those?

That’s why we’re investing in something new. We’ve always liked the last and the NBBO because they are fast and they are real. Now we also offer NASDAQ Velocity and Forces data. Like level II used to be, this is the way to see the orders before they happen. Unlike level II data these orders are real. While there is no such thing as the Holy Grail in terms of predictive value this is the best way to gauge the real market sentiment, as quickly and accurately as possible.

Please check out our new alerts and filters.