Themis Trading will be known to Assiduous Readers due to its presence on the right-hand links panel. Sal L. Arnuk and Joseph Saluzzi write in Toxic Equity Trading Order Flow on Wall Street:
More than half of all institutional algo orders are “pegged” to the National Best Bid or Offer (NBBO). The problem is, if one trader jumps ahead of another in price, it can cause a second trader to go along side of the first one. Very quickly, every algo trading order in a given stock is following each other up or down (or down and up), creating huge, whip like price movements on relatively little volume.
This has led to the development of predatory algo trading strategies. These strategies are designed to cause institutional algo orders to buy or sell shares at prices higher or lower than where the stock had been trading, creating a situation where the predatory algo can lock in a profit from the artificial increase or decrease in the price.
To illustrate, let’s use an institutional algo order pegged to the NBBO with discretion to pay up to $20.10. First, the predatory algo uses methods similar to the liquidity rebate trader to spot this as an institutional algo order. Next, with a bid of $20.01, the predatory algo goes on the attack. The institutional algo immediately goes to $20.01. Then, the predatory algo goes $20.02, and the institutional algo follows. In similar fashion, the predatory algo runs up the institutional algo to its $20.10 limit. At that point, the predatory algo sells the stock short at $20.10 to the institutional algo, knowing it is highly likely that the price of the stock will fall. When it does, the predatory algo covers.
This is how a stock can move 10 or 15 cents on a handful of 100 or 500 share trades.
This is the type of behaviour considered desirable by Omega ATS in their response to the pegged order consultation.
So the question is: is such behaviour a Good Thing or a Bad Thing?
I suggest that this is a good thing. Intra-day volatility leads to a wider variety of entry- and exit-points for real-money players who have bothered to calculate entry- and exit-points. If I own Stock A and want to swap it into Stock B, I must definitely have a spread in mind: if I don’t, then I am grossly incompetent.
Themis’ example represents a bleeding of money from incompetent real-money players into those of the day traders and to competent real-money players; thus, it can be thought of as a Public Good, since it will serve to help differentiate between skill levels on the buy side.