Flash Boys and HFT – Thoughts from the Aquarium

April 11, 2015

Dear AQUA friends and prospects:


Greetings from the Aquarium!


This week’s flash boys controversy cries out for informed discussion. Here are my quickthoughts:


1) If we were a sports league the commissioner would fine an owner who told a nationaltelevision audience that the game is “rigged.” Very bad for our industry and, given the role ourindustry plays, bad for our economy, bad for our country. Especially bad if it isn’t true.Problems? Yes there are market structure problems. But “the market is rigged” ‐‐ wow, notgood.


2) The real problems are those facing institutional investors, not retail orders. If the problem isthat my order executes on BATS first, and then I have problems completing my order becausethe HFT guys beat me to the same prices at all the other exchanges ‐‐ that just doesn’t soundlike a retail problem to me. Apparently the problems of institutional investors don’t sell books.Implying that large order problems (which are real) also plague the retail investor – that’s asleight‐of hand that sells books.


3) I have a real problem with guilt‐by‐association. Chapter 4 of Michael Lewis’ book implies thatthere’s something nefarious about hiring someone who formerly worked for Bernard MadoffSecurities. I was once one of 10,000 employees at Drexel Burnham Lambert while MichaelMilken was parking stock for Ivan Boesky. (Yes, I’m that old.) I hope that never gets out. And forsome reason if one firm hires from the HFT industry, that’s evidence they are selling out theirclients to HFT predators, whereas when another firm hires ex‐HFT it’s obviously to protect theirclients from them.


4) We should know by now that regulatory solutions ‐‐ while sometimes necessary ‐‐ alwayscome with unintended and unexpected results. It amazes me how many otherwise antigovernmentfree marketeers demand government intervention as their preferred solution tomarket structure complaints. Sometimes government action is the only solution – but notusually. Where possible we should prefer solutions introduced by private competitors whoeducate their clients and offer different and better services. IEX has what appears to be acompelling private solution for the high‐speed algo world.


5) AQUA offers a compelling block trading solution to problems faced by large orders – availablenow, without an act of Congress. How do we help? Block liquidity without block leakage.One of the most sophisticated tools you can use today to combat information leakage is still theblock trade. As the equity markets evolve, block trading is becoming an ever more usefulstrategy. It’s always been true that trading in block sizes limits information leakage. Whetheryou access block liquidity through discrete upstairs inquiries or through an ATS like AQUA, youcan get your price with a block before the market knows about your order. Think of all thosesmart people whose skill lies in the ability to detect buying or selling pressure in the trail ofmarket data that follows an algorithmic order.


One way to manage your footprints is to use a better algorithm. Another way is to just leavefewer footprints. That’s the effect of a large block print. Fewer footprints. Less market data onthe tape for smart people to interpret.


Block trades create their own liquidity. When a block print hits the tape, interested parties reactto this information by injecting more liquidity. There are two reasons for this phenomenon andboth reasons are positive for the institutional trade: first, block trades call forth natural liquiditythat’s waiting for natural liquidity. A large print attracts attention and signals to institutions withpotential to participate on either side of the market that they should come in for a liquidityopportunity. We’ve all seen this happen. Print goes up, traders hit the phone, moremerchandise arrives.


The market data generated by algorithmic orders does not attract natural liquidity that’s notalready present in the market. If anything, what algorithmic orders generate in their wake ishigh‐frequency activity. Not institutional activity. Whereas block trading will often trigger theinjection of small‐order liquidity in its wake. Many of the more popular algorithms are paced toparticipate as a percentage of the market’s volume. Block trades put these algos behind theirtarget percentages and they react by injecting catch‐up liquidity.


Aqua’s unique price discovery feature rewards those who provide block liquidity, and Aqua’srevolutionary technology and workflow guards against pre‐trade information leakage.


Liquidity without leakage. That’s what we’re about.


Thanks and regards,


Kevin Foley

President and CEO