In other words, HFTs could get around Rule 610 and the ban on locked markets by mastering this powerful exception that permitted the HFT to “step in the middle” and lock an away market. However, this exploitation of a clever end-around of Rule 610 presented a new problem: how to simultaneously maintain queue rank and get converted from a hidden order to a displayed order. Because hidden order types are ranked below displayed quantity according to binding exchange order precedence rules, the utility of such orders was fleeting unless a mechanism could be provided to reserve one’s place at the top of the queue when the market displayed.
“Hide and light” order types solved this problem of reserving a superior queue position by, in the industry jargon, “lighting” the hidden order automatically when the order would no longer result in a violation of Rule 610 (i.e., when the away market “unlocked”). In other words, the primary advantage embedded in a “hide and light” order was its ability to transform from a hidden order into a Protected Quotation at precisely the time a market was permitted to display an aggressive price. It should come as no surprise that the power of the order type was almost purely in its ability to get an HFT to the top of the queue.
Hence, the “lighting” process became key to dictating an HFT’s queue position. In essence, “lighting” is the key event in which an exchange picks the winners and losers in achieving a superior queue position.
Most institutions are not even aware of the dependence of HFT strategies on exchange “lighting” events. For several years, and including to this day, the mechanisms through which orders that “hide and light” are converted from hidden orders to be rebooked as Protected Quotations are improperly and inadequately documented.
Over the period from 2007 to 2012, the introduction of special order types that “hide and light” proceeded quite quickly, as exchanges matched each other feature for feature with intense competition for HFT order flow. NASDAQ released Price to Comply. BATS released Display-Price Sliding. NYSE ARCA released Post No Preference Blind. Direct Edge released Hide Not Slide. Such order types were repeatedly modified, usually to address specific microstructure nuances that primarily impacted HFT scalping strategies. For example, certain exchanges eventually modified the feature set of order types that “hide and light” to define the specific conditions in which such orders would interact with midpoint liquidity. Another area of modification involved the conditions in which aggressive “post-only” instances of such orders would incur taker fees instead of the intended rebate capture. Lastly, the “lighting” process itself evolved significantly on a number of exchanges.
For what might appear a relatively simple order type, the number of permutations, modifications, and microstructure features (many material elements of which remain undocumented) that were introduced over this period for orders that “hide and light” is astonishing.
It is important to note that exchanges did not mandate the use of “hide and light” orders, but the importance of such order types for those HFTs engaged in “spam and cancel” strategies was undeniable. For all practical purposes, hide and light orders existed to assist HFTs in getting to the top of queue, particularly ahead of “spam and cancel” strategies.
BATS, being particularly aggressive with the adoption of special order types that “hide and light,” summed up quite elegantly the appeal of such order types: “Display-Price Sliding eliminates the need for traders to retry orders multiple times in rapid succession trying to be high in priority at the next NBBO price.”
Where was the institutional client in all of this? For institutions using default exchange modes that subjected their orders to traditional price-sliding, they remained placed a tick back at the back of the queue away from the trading action. Even institutions that utilized orders that “hide and light” intentionally or as a default option -- but that were not versed in the special relationship between Rule 610, the processing of the SIP feed, exchange order matching engine practices, and the special order types themselves -- were unlikely to send orders in the appropriate usage conditions.In fact, HFTs themselves did not think institutional order flow had a competitive stake in the game at all. They thought of the battle as HFT vs. HFT. And they were right. Yes, speed matters -- but only if you know what order type to send and when to send it.
In summary, to address the ban on locked markets, exchanges provided special order types that would “hide and light” orders. These order types were not mandated by exchanges, but appealed to high-speed traders formerly engaged in “spam and cancel” strategies. While HFTs employing “hide and light” order types faced off against older “spam and cancel” strategies, the institutional investor had become even more sidelined by an HFT-oriented market structure, unable to effectively participate in the trading action.
In the next article, we will explore the evolution of Intermarket Sweep Orders (ISOs) and the unique relationship between such orders and the “lighting” process on an exchange. In fact, the ISO, veritably the queen of special order types, is particularly powerful in its ability to step ahead of special order types that “hide and light.”