June 3, 2012

Are NBBO Quotes Still Relevant?

Are NBBO quotes still relevant? The flaws in NBBO quotes across exchanges – NASDAQ, NYSE, BATS, …
NBBO, National Best Bid or Offer, is intended to provide all market participants with the same quotes.

Good intentions.

But, an inherently faulty design of the NBBO creates loopholes that people can exploit. And, High Frequency Traders are happy to exploit these loopholes at the expense of other market participants.

Per Nanex, similar to what happened during Facebook IPO, the NBBO quotes are routinely ignored by the High Frequency Traders. 
Each exchange computes the NBBO internally from direct connections to other exchanges. As the speed of trading increases, the likelihood of any two exchanges having the same NBBO decreases. Most of this is because of the pesky speed-of-light limitation.

So how does a trader know whether a trade was routed properly to the exchange with the best price?

He doesn't. It is impossible.

You see, each exchange’s view of the other exchange prices only exists in memory on that exchange's machines. It is not recorded. There is no audit trail. Sure, each exchange provides book-level data, but that only includes prices for that one exchange — not the prices that existed on the other exchanges at the time of each order.

We have discovered a few anomalies when analyzing aggregation characteristics of CQS, which is the SIP for stocks listed on NYSE, AMEX, and NYSE Arca (home of many ETFs). One disturbing anomaly is that the SIP appears to be ignoring the timestamp in the quotes it receives from an exchange, using instead the actual time the SIP receives the quote, even if the timestamp in the quote is over 5 minutes late. That is, we found an example of the SIP treating 5 minute old data as real-time, affecting the NBBO in thousands of stocks.

Tags: NBBO quotes broken, NBBO quotes bypassed, NBBO quotes ignored, bypass NBBO quotes, best bid and offer quote