Equity Market Fightings: The Reappearance Of The Central Limit Order Book

Equity Market Fightings: The Reappearance Of The Central Limit Order Book

Episode Regulation NMS

Equity Wars: Return of the Central Limit Order Book

A long time ago, in a market far, far away.

Mary Shapiro returns to the financial industry as chairperson of the US SEC attempting to rescue the US investors and markets from the clutches of the vile fraud and high frequency traders.

Little does Mary know that the high frequency traders have developed faster and deadlier trading tactics more powerful then the first dreaded May 6 flash crash.

When completed, this ultimate weapon will spell certain doom for the small band of mom and pop investors struggling for faith in the US markets.

Not too far away the wild wild west exists. Innovation existed with the land symbiotically in the wild wild west. California had an exchange called the Pacific Stock exchange. The Pacific Stock exchange was two stock exchanges living symbiotically with dual order books. This was the first and only US Central Limit Order Book (CLOB) in America. The Pacific Stock Exchange was connected to the Intermarket Trading System (ITS) which was mandated by Congress to connect the primary markets (NYSE & AMEX). The west coast Pacific Stock Exchange was a test of the CLOB. It was shortly lived because of various political reasons with ECN's and market makers. An example can be seen with this statement back then: "If the CLOB has any life left in it, we'd like to put the stake in it" says Kevin O'Hara, general counsel of ECN Archipelago. Through various issues and problems, the Pacific Stock Exchange was merged with Archipelago for its Self Regulatory Organization "SRO". Shortly after the deadly merger, the floor shut down along with it's innovative CLOB. Although the exchange shut down, the idea remains.

Canada was also operating under a very chaotic market structure but took the opportunity to embrace the CLOB idea. The essence of this idea, price time priority created a more fluid market structure than the much fragmented US market structure. Today the Canadian market is very dynamic and structured. The volatility of the market also seems to be less than the US markets.

Currently, the US markets have about 30+ various displayed & dark markets. After Reg NMS, the market structure became an evil cluster. Various exchanges popped up along with even more dark pools. Having all these various markets created a very fragmented market structure. All these fragmented markets create less competition because time/ price priority is not considered. Without time price priority there is not much of an incentive to post an order longer than a few milliseconds. Exchange, market maker, and wholesaler competition for order flow does not exists today. The original plan was for competition for order flow to create more efficient markets and better executions.

As a result of the evil market structure, we have new terms like flash crash and splash crash. The evil market structure is different today. The biggest reason of the change is because of Reg NMS. There are now liquidity issues, vacuums, mini crashes, and whatever else happens when you have no participants in the market because of this new structure. There is an old term called "If you pay them they will come", or "If you don't pay them they will leave". The most obvious and easiest method of fixing the evil nightmare is creating a CLOB. This will force liquidity into the marketplace. The first step to improving the market structure should be a CLOB with all the dark pools. This would promote order display in the dark pools and eliminate gaming. After that has been proven successful, the displayed markets should have a CLOB. These two super CLOBS (dark & displayed) will force liquidity into the market. All participants will have to be forced to display their orders to get filled. The NYSE and the various exchanges have the biggest incentives to push this new model. May the force be them

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