Making Sense of Market Fragmentation

Complex market structures are here to stay and will just get more intricate and convoluted in the future as regulation and fragmentation create opportunities for existing providers and new data vendors enter the fray. With the profusion of Exchanges, ECN’s, Dark Pools and ATS’s  the result is a elaborate maze of market complexity with pools of liquidity scattered everywhere.  Thus creating a labyrinth for investment firms to navigate – ‘where can we find BBO? Best Execution?“. This complexity is here to stay and is expanding.

Fragmentation and venue-specific market structure has been the norm in Foreign Exchange for a long while.  This is due to the ECN’s and single bank liquidity providers jockeying for position to provide uniqueness in the best/fastest rates, broadest set of currency pairs and other products beyond Spot.     MarketFactory’s diagram does a good job of illustrating just how polar opposite Equities and FX are presently.

I recently read this article on the TABB Forum by Melanie Wold, time to stop the Market Structure Madness. Where she explains the burgeoning fragmentation in the U.S. Equities market, where we have 12 Exchanges, and proliferating European venues have sprung up like Holland tulips.  As Melanie describes, the suspicious eye would look closely at this entangling of market complexity as a culprit behind the May 6th flash crash.

Another related event is the potential unraveling of the CME Group’s near monopolistic control of the futures market in an anti-trust regulation suit against them by rival ELX.  Such a move will likely be a springboard for startups similar to ELX to jump headlong into the futures markets. No one likes a monopoly, there are laws against it and most people like to root for the underdog, so the outcome of this seems clear.

If you’re a quantitative analyst and/or a trader this market complexity resembles pea soup. You may have ideas and theories about Alpha  possibilities within this complex market structure, but how do you vet those ideas and then turn them into actionable strategies?   The need to dissect and analyze market data across multiple venues to discover trading patterns comes from a Research and Trading  platform that mediates the complexities of multiple markets,  provides a broad set of functions across  both unified and venue-specific views of Order Books, Quotes and Trades.   Finding the right tools to do this effectively can be as daunting a task as deciphering the markets.

The rampant complexities occurring in market structures and the May 6th flash crash are the fuel that will cause the SEC to enact regulation as we have already seen in the form of circuit breakers, and likely to follow rules against quote stuffing and stub quotes. The Exchanges have also increased their liquidity provisioning requirements by market markers all in an effort to prevent another crash (flash or otherwise). But none of this is going to stem the tide in increasingly complex and fragmented markets, the multitude of data vendors provide that assurance alone. It is here to stay. Get prepared and arm yourself with the right tools.

Once again thanks for reading.

For an occasional opinion or commentary on technology in Capital Markets you can follow me on  twitter, here.

About Louis Lovas

Director of Solutions, OneMarketData, with over 20 years of experience in developing cutting edge solutions and a leading voice in technology and trends in the Capital Markets industry.
This entry was posted in Algorithmic Trading, Analytics, Complex Event Processing, Equities, Foreign Exchange, Futures and Options, Tick database. Bookmark the permalink.

2 Responses to Making Sense of Market Fragmentation

  1. Good summary Louie. The CME/ELX case is a very interesting development which (at a high level at least) parallels what has happened in the Equities and FX markets. The CME’s in-house clearing of its trades – and the consequent power to make the rules – gives it a strong lever which may well take regulation to counter. I’m watching with interest though – Apama connects directly to both CME and ELX and we’re not exactly unfamiliar in the space of multi-market liquidity aggregation and smart order routing! Take care, and keep posting –Richard

  2. Pingback: HFT Regulation, One Step At a Time | OneMarketData's Blog

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