03.08.2018
By John D'Antona

Taker-Maker Doesn’t Hurt ‘Best Ex’

So, does posting an order on an exchange that employs an inverted or taker-maker pricing scheme hurt the institutional trader?

Does posting on an inverted exchange result in better executions than if a trader placed his order on a regular or maker-taker exchange?

Pragma Securities, an independent algorithmic trading and TCA provider, has shared with Traders Magazine some of it latest research on inverted exchanges. The research comes amid concerns from some that orders placed on inverted venues cause the market to move through information leakage, ‘signal the market’ or compromise execution quality.

An inverted exchange pays a rebate to liquidity takers rather than charging the standard fee. These orders effectively ‘hop the inter-market queue’ and have a probability of fill. However, some traders remain concerned that posting orders on an inverted exchange may degrade performance by leaking more than orders on regular exchanges.

Many market participants post on inverted exchanges only when they believe the price is likely to run away due to a large quote imbalance, and they want to increase the chance of their trade being filled. I wanted to share some research with you relating to execution on inverted exchanges, and whether it results in higher leakage or higher quality of execution when compared to posting on a regular exchange.

There are also concerns amongst some market participants that orders on inverted venues cause the market to move through information leakage, ‘signal the market’ or compromise execution quality.

Pragma Securities research says, “no,” and not to worry about to these concerns after analyzing how its VWAP algorithms perform. Pragma found that these aforementioned concerns are unfounded. Its data shows there are no adverse levels of leakage results from posting on inverted exchanges, and the execution benefits of ‘hopping the queue’ on regular exchanges are consistent with previous studies on this topic.

“Many market participants post on inverted exchanges only when they believe the price is likely to run away due to a large quote imbalance, and they want to increase the chance of their trade being filled,” the report noted.

The study involved Pragma examining over 1 million child orders. To escape the unknown biases of open market data and answer the question of whether inverted exchanges have more information leakage, Pragma used a proprietary data set of Pragma’s passive child orders from a VWAP algo set up to make a randomized decision of whether to post on a regular or an inverted exchange, in order to allow for a fair apples- to- apples comparison. The data set includes all the information about the algo’s microtrading, including new orders, any modification to the orders, and fills and cancels. The orders in the data set were entered at the near touch price, and repegged to the near touch if the price moved away. If a passive order is not executed within an allocated time, the algo order falls behind its schedule, cancels the passive order and crosses the spread. Unfilled passive orders, therefore, are charged the far touch at the time of cancel as a clean-up cost.

“The execution quality benefits of posting on inverted venues are, by now, well documented. This research addresses a lingering concern of some market participants—that inverted venues might “signal the market” and compromise execution quality by making subsequent orders start at an inferior price. We provide direct evidence from a controlled experiment that this concern is unfounded,” Pragma noted. “We find no evidence of worse residual information leakage when posting on inverted exchanges, and, consistent with previous reports, observe better execution quality, exclusive of exchange fees.”

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