High-Frequency Trading: What Do Predatory Order Types Have To Do With Investing?

May 8, 2014 4:47 PM
By Ted Oberhaus

Exchanges have created hundreds of order types that benefit the predatory practices of high-frequency traders

A Trader's Perspective

Most investors are familiar with the concept of an order type, which instructs a trader to enter or exit a position. Common order types include the stop-loss order, which attempts to limit trading losses by drawing a “line in the sand” past which traders will not risk any more money; the limit order, which is an order to buy (or sell) at a specified price or better; and the market order, which instructs the trader to buy (or sell) at the best price that is currently available. Many investors think of these three order types as their main options. But the exchanges have created many more order types—hundreds upon hundreds of them—and many of them are not fully understood.

Moreover, according to Reuters, order types can reach an estimated 2,000 variations in a fully electronic market, and more than 50 trading venues have multiplied the possibilities of how, when, and with whom to trade. Critics allege that exchanges have created these new order types to allow high-frequency traders (HFT), which represent a growing portion of their business, to trade ahead of slower-moving market participants. 

Drawing the ire of many market participants outside of the HFT community are the so-called “predatory” order types, such as “hide not slide” and its numerous variations, which allow HFTs to hide orders and prevent them from routing to other exchanges where the traders may have less control over the order execution.  

We believe eliminating some of these order types is the first thing that regulators should do as they re-examine the market structure. Unfortunately, the Securities and Exchange Commission (SEC) has blessed many of these order types, which leads to suspicions that the exchanges have not been as forthcoming with the agency as they might have been when they first sought approval for them, thus making any probe by the SEC a little tricky, to say the least.    

The good news is that the criticism of these predatory practices is reaching a peak, and we anticipate a solution not too far down the road. Let’s hope we’re right. Investing should be about providing capital to the world’s most promising companies, not about tricking the trade. (Recommended reading: "High Frequency Trading: The Tricks of the Trade.")

What do you think? Join us in this investment conversation.

Ted Oberhaus is a Lord Abbett Partner and Director of Equity Trading.

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