A Deliberate Strategy
This post addresses a common question related to IEX’s newly-proposed order type, D-Limit, which you can read about here.
You might wonder, if so much of trading happens while the Signal is “on,” is everyone doing it? In targeting these periods, will D-Limit impede normal liquidity taking?
The answer is no. Liquidity taking while the Signal is “on” is not something that consistently happens by accident; it’s typically part of specific opportunistic strategies put on a by very narrow set of firms.
In November 2019, just 3 member firms at IEX were responsible for 55% of all the lit taking volume while the Signal was “on,” even though those firms accounted for only 13% of the total volume on IEX. For comparison, the top 3 firms on IEX overall (which do not overlap with the 3 firms above) account for only 29% of our total traded volume, a much lower concentration.
Still, it is fair to wonder if your firm will miss liquidity because you will not be able to take against resting D-Limits while the Signal is “on.”
To answer that question, we grouped member firms into 3 main categories: full-service broker-dealers, agency broker-dealers, and proprietary trading firms and plotted when they sent aggressive orders relative to when the IEX Signal made its prediction that the price was likely about to change.
In the charts above, zero is the moment the Signal made the prediction, and the bars represent the average daily shares sent to IEX that are marketable to the far side (e.g., sellers trying to hit the bid).
As you can see, the majority of orders we receive from full-service and agency broker-dealers occur before the prediction is made, while proprietary trading firms send orders primarily after the prediction (and at a 16 times greater magnitude).
It is not a stretch to infer that a small subset of proprietary trading firms are trading against both bona fide market makers and other liquidity providers by predicting that the price is changing and leveraging small latency advantages to trade based on that information. Because these orders come in after the Signal has turned “on,” D-Limit orders would have repriced by one MPV before the aggressive orders could opportunistically trade against the resting order.
On the other hand, when full-service and agency broker-dealers take liquidity, their orders come in before the Signal is “on,” suggesting that they are the “event” that triggers the prediction made by others. Their orders, which represent the normal course of trading, come in before the predictions can be made and will be able to access the liquidity they see before the Signal fires — exactly what both sides of the trade want.
 IEX classifications are on a best efforts basis by member firms’ trading sessions.
 This chart only plots marketable shares received in the 2 milliseconds before and after the Signal turns “on.” In November 2019, the Signal was only “on” for approximately 4 seconds per symbol per day on a volume-weighted basis. Flows sent to IEX outside of this window when the market is stable are excluded because D-Limit orders will not be repricing and race conditions are not a concern.
 To reiterate, not all proprietary trading firms are running these strategies. In fact, many of the leading proprietary trading firms are bona fide market makers whose liquidity is critical to pre-trade price discovery. Ironically, as much technical and financial sophistication as it takes to compete as a market maker, they still end up adding while the Signal is “on,” and their average execution quality suffers from these trades. The reason a proprietary trading firm market maker would get picked off by other proprietary trading firms is because market makers are at a structural disadvantage to market takers. On IEX, there are system limitations that constrain messaging of a market participant with the matching engine, most notably the “one message in flight” restriction. When a market maker needs to reprice hundreds, possibly a thousand or more orders they can effectively only process as many orders at a time as they have sessions.
 The D-Limit orders are still accessible via an intermarket sweep IOC order, albeit at price that reflects where the market is likely heading rather than the stale price.
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