Incentivizing a Better Market
The goal of IEX has always been to help natural investors better compete by weakening the speed-based edge that the fastest traders have over investors and their agents. Trading is — rightfully — competitive, but when certain intermediaries can gain an edge based on raw speed rather than real alpha, the quality of the market can be undermined.
This speed-based edge is purchased from exchanges, who have evolved their business models over the past decade from generating trading commission revenue into operating massive data and colocation businesses. Most exchanges’ revenue depends on monetizing speed and complexity, while at IEX, we’ve spent our time and energy trying to blunt those same forces.
To date, many of our innovations in this area have made IEX a destination for high-quality non-displayed trading. This week, we’re launching our latest innovation: a first-of-its-kind fee that is designed to improve all trading, including the experience of displayed orders, on IEX.
First, A Look Back…
Building on IEX’s much-chronicled speed bump innovation, in 2014 we introduced the IEX Signal, also known as the Crumbling Quote Indicator (CQI). We developed this model when we noticed predictive strategies picking off slower investors while prices were in the process of changing; the Signal is a counter-solution that brings those predictive capabilities to investors trading on IEX, helping insulate them from near-instant buyer’s and seller’s remorse. The Signal is now deployed in two of IEX’s order types: the patent-pending Discretionary Peg™ (D-Peg®) and Primary Peg, both of which behave more conservatively when the price is in the process of changing in their favor.
Even though the Signal is only in effect for tiny windows of time — about five seconds per symbol per day on a volume-weighted basis — over 30% of all marketable orders[1] arrive at IEX during these five seconds. Think about that again: five out of 23,400 seconds in the trading day is 0.02%, yet over 30% of all the marketable orders IEX receives in the course of an entire trading day arrive in that sliver of time. Hardly a coincidence — these orders flood IEX and other exchanges in these specific moments of time looking to trade at prices that will likely be stale almost immediately.
This imbalance shows the prevalence of specific strategies that target these periods of time, at the expense of investors. One way to improve the performance of investors, algorithms, and market makers on IEX, then, is to weed out some of the poor trades caused by these opportunistic, predatory orders. If there are fewer bad trades on our books, we believe that IEX’s performance as a venue will improve and rational actors will allocate more of their trading to the venue that is providing better trading outcomes.
The Signal Fee
That is why on January 2, 2018, IEX implemented the Signal Fee.[2]
Leveraging the Signal’s ability to determine when a price is in the process of changing, we will now charge participants the maximum fee for trades that remove liquidity during these moments — if such aggressive order flow appears to be deliberate and not an incidental portion of their trading activity.
Our expectation is that by changing the economics of these toxic strategies, we can make them less lucrative, discouraging participants from practicing them, at least on IEX. We are not trying to pick winners and losers, but we’d like to see both sides of a trade come out of the starting blocks even.
For an exchange whose primary revenue comes from matching trades, it might seem odd to disincentivize volume. However, we’re hoping that higher-quality trading for market makers, investors, and algorithms will result in long-term growth for our market.
In particular, the Signal Fee is designed to enhance the displayed trading experience on IEX. Until now, displayed trades did not benefit from the protections of the Signal, but by discouraging harmful counter parties, this fee should protect investors and market makers alike when they display orders on IEX.
Why Use a Fee?
Economic incentives matter, particularly in equities. Rather than paying a rebate that creates a potential conflict of interest for market participants, we’ve chosen to use a fee to discourage certain trading strategies. The Signal Fee enables us to continue our track-record of precisely targeting strategies that are harmful to the market.
How Will it Work?
If an IEX member firm’s removed volume while the Signal is “on” exceeds both 5% of their total IEX volume and one million shares for the month (on a monthly MPID-by-MPID basis), a fee of 30 mils per share will be applied to all such incremental volume above this threshold.
It’s not a coincidence that such a large portion of aggressive orders come to IEX while the Signal is “on.” We believe that anyone who would qualify for the fee knows what strategies to turn off to avoid paying it. In addition, we will provide a real-time indicator on execution reports identifying trades that count toward this threshold so firms can monitor and adjust accordingly.
We are excited to offer this new, groundbreaking feature designed to improve trading performance on IEX and further marginalize the role of speed and mechanical edge on our market. We look forward to working with you to continue improving your trading experience on IEX in 2018.
[1] Priced to the far side.
[2] Known as the Crumbling Quote Remove Fee on the IEX fee schedule.
About IEX
IEX is on a mission to build fairer markets. Founded in 2012 and headquartered in New York City, IEX introduced its first trading venue in 2013 and launched as a U.S. stock exchange in 2016. IEX is the stock exchange that believes that every investor has the right to trade on equal and fair terms, on every trade. Learn more at: iextrading.com.
© 2018 IEX Group, Inc. and its subsidiaries. Neither the information, nor any opinion expressed herein constitutes a solicitation or offer to buy or sell any securities or provide any investment advice or service. The information herein is believed to be reliable, but the Firm makes no representation as to the accuracy or completeness of, and undertakes no duty to update, information herein.
