We all assume our markets to be efficient, but just how efficient are they really? On March 3 at 12:13:36, market inefficiency caused the spread in the heavily traded SPY ETF to become inverted, as illustrated in the charts below. While the negative spread only lasted for a bit more than 500 milliseconds, it raises serious questions about the efficiency of our markets, and it also puts the implementation of Reg NMS into question.
Should the markets ever experience negative spreads in the age of Reg NMS and HFT? Since quotes, and sometimes trades, occur at the microsecond level, one would expect our technologically advanced markets to be extremely efficient and such conditions to be corrected in a matter of milliseconds, if not microseconds.
So how do we then explain the chart below, which depicts the above-mentioned instance when the market in SPY got crossed and stayed crossed for more than 500 milliseconds, reaching at its widest a negative spread of nine cents – Best Bid $184.24/Best Ask $184.15? The market not only gets crossed, but the Bid and the Ask appear to be moving independent of each other, with the Bid climbing higher and higher, from $184.14 to $184.24 in 10 different moves, while the Best Ask seems stuck at $184.15. The Best Ask finally starts moving up but still stays below the best Bid for the approximately 500 milliseconds in question.