Flash Orders

Flash orders have been used for years but have become increasingly popular in recent months as more traders and exchanges adopted the approach. Last week WSJ reported that US SEC is considering a ban of flash orders. The Chairman Mary Schapiro said she has asked SEC's staff to develop a proposal to eliminate the inequity that results from flash orders.

Flash order technology means high-frequency trading, a lightning-fast, computer-based trading technique. It allows some traders to have a sneak peek at market activity, giving high-frequency traders an advantage over retail investors.

Flash orders were pioneered by the Chicago Board Options Exchange's stock exchange earlier this decade as that exchange looked for a way to improve execution speeds. Flash remained a niche part of the industry until around June 2006, when a small stock-trading platform, Direct Edge, owned by Knight Capital Group Inc., adopted the practice. Now, Direct Edge is the third-largest stock trading platform by matched volume in the country. Its success has helped prompt competitors to adopt their own versions of flash.

In a flash order, a firm wishing to buy or sell stock can elect to freeze the order on an exchange for as long as half a second. This move can have several effects, one of which concerns a system of rebates and fees on trading orders. Typically on trades, exchanges pay rebates to traders who post shares to buy or sell and charge fees to traders who respond to those offers. This setup creates an incentive to earn rebates. A flash order puts a trader in the position of poster, rather than responder. The hope is that another trader who needs to buy or sell quickly steps in on the other side of the trade. This dynamic boosts the chance the flash-order trader will complete the trade on the exchange and get the rebate.

The following diagram found from the internet explains how flash orders work:

Critics say that flash orders give the high-speed traders a window into the direction of the market, giving them the ability to trade at lightning speeds ahead of less fleet-footed investors. On the other hand, flash-order advocates say the orders help traders get better prices. They say a ban could cause trading volume to drop on the exchanges that permit flash as traders look for better execution in alternative, less-transparent venues.

Meanwhile, in a sign of regulators' growing concern about evolving electronic trading, SEC staff is also studying rules for so-called dark pools, private electronic-trading networks that match buyers and sellers anonymously. The pools have been gaining market share in recent years as more trading firms use them.

SEC staff is looking at requiring disclosure of post-trade information to show which dark-pool operator is executing which trades, according to people familiar with the matter. That would give investors a better idea of the liquidity and depth of a particular operator. SEC is also considering whether to have the information disclosed on a real-time basis or collected and disclosed in an aggregate form.

Another area under review is the "indications of interest," which are similar to flash orders. If an exchange can't execute an order, it will look at indications of interest from a number of dark pools. Rather than flash the order for a potential mate, the exchange can route it through the dark pools that expressed indications of interest.

Are you dazzled by the flash?