Speedbump Markets: Fair, Unfair or Just the New Fashion Accessory?

Speedbumps are implemented to benefit liquidity providers by slowing down marketable orders (market, IOC, and marketable limit orders) to reduce the adverse selection risk of posting limit orders. In other words, marketable orders are slowed so limit orders won’t get picked off. They also dissuade fast traders who want to quickly post and cancel orders, given the pause length may be longer than the trades’ optimal order life.

Liquidity providers in this instance do not necessarily mean market makers or “liquidity providers”; rather, it means anyone posting a limit order, and for those posting dark or pegged limit orders, the platforms with speedbumps are especially valuable.

To fully understand speedbumps, you need to understand speed. Speed is used for two major purposes: capturing opportunity and managing risk. These are two sides of the same coin. The fastest person to find an opportunity can be the first person to capture it. On the contrary, the slowest person posting is generally the opportunity that is being taken advantage of.

This is especially true in our US equities multiple market model.

While the thought of an automated speedbump for continuous or semi-continuous trading is fairly new, the way pauses and/or speedbumps are implemented can be very different. Speedbumps, while generally employed to protect resting limit orders from adverse selection, can also be used when combined with different market data strategies, or pricing mechanisms, to preference, protect, or even take advantage of different types of trading styles and strategies. They can also be used to give liquidity providers a last look to ensure that they aren’t trading at a disadvantageous price. In addition, how speedbumps work in relation to different regulatory regimes will have a very significant impact on price discovery, market efficiency, and even the cost of market infrastructure including market data, co-location, and investments in reducing latency.

While speedbumps seem to be in fashion, we have a hard time believing that the speedbump craze will take over all markets. However, given the high-profile fight over speedbumps we are seeing in the US equity market, if the SEC approves a blanket 1-millisecond grace period, and/or IEX obtains their exchange license with its incorporated speedbump intact, we believe the idea of developing and incorporating speedbumps into markets will gain significant exposure and traction.

If speedbumps become the new fashion accessory, the one thing that we can count on is that we will not see one specific type of bump.  Each market has a very different speedbump model that preferences and/or deters have very specific behaviors. Each model will be different and each model will need to be analyzed to determine the impact of each pause on a firm’s trading strategy.

This TABB Group Focus Note covers the purpose, design, and impacts of speedbumps on financial markets including reducing adverse selection, better pricing of pegged orders, and enabling an automated last look mechanism for OTC products.

Products/Markets Covered: US Equities, Canadian Equities, FX, Equities Auction models

Speedbump Models Covered: IEX, TMX Alpha, Aequitas Neo, ParFX, EBS, PDQ, & CHX