Stopping the NYSE Arms Race with Discrete Auctions

Dec 16, 2009 11:20pm

Way back in August, I threatened to propose an alternative stock brokering system for the New York Stock Exchange (et al).

Background

The service an exchange provides to the market is liquidity. More than matching buyers and sellers, more than clearing transactions, an exchange’s “specialists” have their own cache of stocks so that there’s always some available for potential buyers.

Current exchanges operate as continuous double auctions. Meaning buy and sell orders are processed as they come in, as fast as possible.

The Problem

Because transactions are continuous, in near real-time, there’s huge incentive to have the fastest, closest computers submitting buy and sell orders. It’s an information technology “arms race”. The result is unfair advantage for the traders that invest more in their communications infrastructure.

The Solution

Replace the continuous system with repeating discrete double auctions. Create a series of auctions for each listed stock.

Auctions could last 5 seconds or 1 hour, adapting the frequency (and duration) of the auctions in response to trading volume.

By predetermining the auction deadline, no trader could have a communications infrastructure advantage (e.g. bigger, faster, closer pipes).

Commentary

Exchanges have opening and closing auction. The mismatch between these auctions and the continuous trading causes heartache. Having repeating discrete double auctions would simplify matters.

Transaction processing for auctions would be more simple and robust, compared to continuous trading.

Setting a minimum auction duration, e.g. no shorter than 5 seconds, might prevent or forestall a computing arms race.

The proposal of repeating discrete double auctions is only meant to address the uneven playing field resulting from the communications and computing arms race. I don’t know if it helps or hurts other identified issues, such as high volume trading, automatic trading algorithms (heuristics), specialists “leading” the market, etc.

This is just a blue-sky idea. I know almost nothing about stocks, finance, trading, etc. I started to read about it. Alas, it’s really not my thing, so I stopped. But I wanted to post this idea, just in case it’s original or helpful.

I couldn’t come up with a better phrase. “Recurring auctions” was on the list.

MMORPGs and other event based simulations have a virtual clock. So would an auction system, I imagine. It’d please me tremendously if game technology found its way into the world of finance.