High-Frequency Trading special order type: ISOs (Part1)
After conducting extensive research on High-Frequency Trading, I would like to share my findings regarding the special order types used on lit and dark markets by high-frequency traders in this article. This topic is quite extensive and difficult to summarize in one article. It could even be possible to write a book just on this topic!
Therefore, I will present the main characteristics of the most renowned special order types used by HFT in a series of multiple articles.
To begin this introduction, it is impossible for an investor to learn about every special order type developed by stock exchanges or dark pools.
In an article in Traders Magazine, BATS GLOBAL MARKETS revealed in 2013 that more than 2,000 special order types exist on US Equity Markets. So, imagine the number of these special order types today in 2023…
Among the special order types, some are open to all investors (retail, institutional, HFTs), like the Post-Only orders, while others are restricted, like the Intermarket Sweep Orders (ISOs).
Today, I will dedicate this article to Intermarket Sweep Orders (ISOs).
High-Frequency Traders need to execute their orders quickly on US markets, especially if they want to capture capital gains through scalping. This is where the Intermarket Sweep Order comes into play. Moreover, the most important aspect for a high-frequency trader is to always be at the forefront of the order book, ahead of other market participants, to have execution priority. This is where the hide not slide order type comes in (I will discuss the hide not slide order type in my next article).
The Intermarket Sweep Order (ISO) is all about speed and quick execution.
First of all, let me be clear: this order is not available to retail investors and is only open to institutional investors and high-frequency traders.
The main goal of the ISO is to trade a bundle of stocks in the same market without wasting time looking for potential better prices (NBBO) in other markets, following the order protection rule of Reg NMS.
This is why High-Frequency Traders use Intermarket Sweep Orders most of the time. They want to buy or sell a bundle of stocks on the same market as quickly as possible, then immediately turn around to close their positions. ISOs are efficient for scalping strategies.
Therefore, an ISO does not adhere to the “Order Protection Rule” (Rule 611 of Reg NMS).
Let me explain: according to this rule, when an investor sends a buy or sell order to their broker, the latter must route the order to the market showing the best quotes for execution (the market with the National Best Bid or Offer, NBBO). NBBO is protected and must be executed with priority.
However, with an ISO order, this is no longer the case. Initially, an ISO has to match an order against the NBBO. But then, an ISO to buy or sell can sweep the same market and execute the order with unprotected quotes (unprotected quotes are quotes that do not constitute the best available prices) on the same market (meaning without looking for the NBBO on other markets). In other words, an ISO does not have to check other market venues for potential better prices (NBBO).
An ISO prioritizes quick execution instead of looking for better prices on other venues.
For example, let’s assume you have this order book on a trading venue (Market1):
Step 1: A High-Frequency Trader sends an ISO to sell 3,000 shares on Market1 with a limit price of $15.4. The first buyer on Market 1 wants to buy 287 stocks at a price of $15.49. However, on another market, Market 2, the first buyer wants to buy 300 of the same stock at a price of $15.495. Therefore, the NBB (National Best Bid) can be found in Market 2, and the HFT will have the possibility to sell 300 shares at the price of $15.495. The ISO is routed to market 2 to sell the first 300 shares at a price of $15.495.
Remember, initially an ISO has to match an order against the NBBO before buying or selling on the same market without looking for the NBBO.
Step 2: After selling the first 300 shares on market 2, the ISO to sell, originally sent by the high-frequency trader to market 1, can now sweep and stay on the same market 1 to sell the remaining 2,700 shares without wasting time looking for better prices elsewhere. The HFT sells on market 1: 287 shares for $15.49 / 400 shares for $15.485 / 2,013 shares for $15.48.
The main reason for using Intermarket Sweep Orders: HFTs want to trade ahead of other market participants to quickly buy or sell a bundle of stocks and then immediately turn around to trade with other investors coming up behind. ISOs are used for scalping.
Additionally, to identify the trading platform with the best price conditions (NBBO), brokers use “Securities Information Processors” (SIPs) linking the US markets. However, the SIP is too slow to aggregate, analyze, process, and send the NBBO to brokers. By the time the SIP (slow feed) identifies the NBBO available on US markets, this NBBO is already stale and does not take into account the new updated quotes on US markets. That is why High-Frequency Traders don’t want to waste their time looking for the NBBO on other markets because they know the NBBO received by the SIP will be stale. HFTs don’t want to miss opportunities.
The SIP deployed by the Securities and Exchange Commission takes a lot of time to identify the NBBO. The time it takes for the SIP to aggregate the data is too long. The NBBO is already stale due to new order flow with new quotes. Instead, HFTs use ISO to sweep the same trading venue and get the latest updated prices. Moreover, HFTs have developed their own SIPs (fast feed) to get the NBBO before the standard SIP of the SEC to deploy their trading arbitrage strategies.
That’s all for me today. In the coming months, I will continue to write articles on special order types and trading strategies used by High-Frequency Traders.
As I always say, do not hesitate to give me your feedback. That is the only way to improve my articles. I hope you enjoy the reading.
Let me end my article with a link to my book on High-Frequency Trading if you are interested:
https://amzn.eu/d/1XErUCl (in French)
https://amzn.eu/d/8B3XznD (in English)
Article was written by William Troyaux, September 23rd, 2023.