Minimum Quantity: Order Protection vs. Venue Optimization

• Near Touch Orders

  Post-execution markouts monotonically increase, even up to 5 minutes out, on passive orders without MinQty versus those with MinQty.

  Interestingly, markouts on unexecuted orders without MinQty have roughly the same markout as executions without MinQty.

  This suggests lack of MinQty reflects urgency and potentially the short term “edge” of the order sender.

  There does appear to be a muting effect on markouts for executions with MinQty versus both orders with and without MinQty and, potentially more importantly, versus orders with MinQty.  T-Statistics are not definitive (pval of .19), but the use of MinQty seems to mute short-term market moves on near touch orders.  However, this comes at a substantial cost in hit rate and order drift that, together, neutralize the gains in post execution markout. This suggests that MinQty is not, in isolation, a sufficient protection from information leakage for near touch orders.

  

  

  

  

• Midpoint Orders

  Unlike near touch order flow, there is less distinction between using MinQty versus not for executions at midpoint.

  Post-execution markouts are very similar across different MinQty levels, even up to 5 minutes out.

  Interestingly, the muted markouts on unexecuted orders supports our intuition that the midpoint is typically used for more neutral flow and that the risk is in executions triggering any negative impact once they have gone to the tape.

  Therefore, we attempt to preference “safer” midpoint venues such as IntelligentCross, IEX D-peg, and Nasdaq M-ELO that decouple matching from market events and show consistently higher post trade price stability.

  However, similar to near side orders, there is still substantial decay in hit rates and an increase in order drift that accompany the use of MinQty at midpoint.

  

  

  

  

• Far Touch Orders

  Not surprisingly, far touch orders are, by their nature, urgent and are not afforded any distinct protection when utilizing MinQty.  Markouts for executions with MinQty are comparable to, or greater than, those without MinQty.

  However, as expected, far touch orders also have the highest markouts.

  In addition, the decline in hit rate and increase in order drift from arrival time to cancel time suggests that attempts to protect markout with the use of MinQty ends up costing a full spread move by the arrival time of the next order.

  

  

  

  

• IOC Orders

  IOC orders are similar to far touch orders in that MinQty does not seem to offer markout protection even though, on balance, zero MinQty orders tend to have higher expected markouts independent of execution.

  Although hit rates drop substantially as MinQty increases, as in the case of all the limit types that we have reviewed, because of the short life cycle of IOC orders, there does not appear to be any significant opportunity cost to sending an IOC with a MinQty assuming that it is followed by a near simultaneous reload.

  

  

  

  

• Initial Conclusions

  From an overall limit urgency perspective (near touch, midpoint, and far touch), we find it difficult to make the case that MinQty utilization provides outsized protection against markouts when considering the decay in hit rate and the increase in opportunity cost due to order drift.

  For example, IntelligentCross suggests that there is between a 40% and 60% cost to hit rate simply by increasing MinQty by 100 shares from the more optimal 100 share to 200 share range during Q1 2020.

  The evidence shows that a broad “set-it-and-forget-it” approach to MinQty does not provide material value.

  However, because MinQty can slow the speed of trading by decreasing liquidity interaction, it can add value as a filter at the venue level.  Essentially, MinQty can enhance performance by acting as a venue optimization tool weighting venue safety vs. overall need for liquidity.

  

• Minimum Quantity and Venue Optimizations

  If we accept our suggestion that, for any given order, MinQty has limited protective value, how can we use it in venue optimization?

  Venue optimization is the selection of trading venues through child order placement to maximize available liquidity while minimizing the implicit costs of trading such as impact.

  Venues have different and persistent performance characteristics. For example, as this plot from IntelligentCross shows, standard Maker-Taker venues typically have higher markouts than Inverted venues before accounting for fees.

  Although venues can loosely fit into a spectrum of more or less safe as measured by post trade market movement, parent order benchmark performance is ultimately most sensitive to the percent of volume demanded.

  There is little guarantee that safer venues can absorb the liquidity demands of larger institutional orders. Because MinQty allows the exchange of urgency for size, it allows us to be more urgent at safer destinations and less urgent at more volatile ones - increasing availability liquidity while prioritizing execution quality.

  

• Venue Optimization in Action

  In our review of MinQty and order types, we saw that using MinQty was potentially beneficial for near side posting.

  If we look at near touch order flow by venue type, we see that Dark and Gray venues without MinQty typically have higher markouts than Inverted and standard Maker/Taker venues similarly configured.

  In this instance, Dark and Gray are an amalgam of “hidden” venues and not just destinations with a reputation for minimal impact.

  However, by imposing minimum MinQty of 100 shares to 200 shares on those venues, we can bring overall performance in line with our highest performing venues while simultaneously increasing liquidity.

  This idea of a minimum MinQty being sufficient loosely comports with a March 2018 study conducted by IEX D-peg.  The study pointed out that while adjustment of MinQty based on stock characteristics was likely superior to other approaches, even the least aggressive setting provided sufficient protection.

  

  We see similar benefits to utilizing MinQty to access more liquidity in the midpoint context as well.

  While protective mid-point venues, such as IntelligentCross, IEX D-peg, and Nasdaq Nasdaq M-ELO, typically have low post-execution signalling, other dark destinations can have substantial leakage. This is shown in the plot looking at post-execution Dark performance with no MinQty.

  However, by adjusting MinQty to a minimum of 100 shares to 200 shares, we see post-execution performance in those venues more closely aligned with the “safer,” or more protective, mid-point destinations.

  In this way, we can balance incremental liquidity with performance by sourcing as much liquidity as possible from unrestricted orders in protective pools while accepting the decline in hit rate to add additional liquidity from less protective pools.

  

Final Conclusions

MinQty, on its own, is of mixed value in protecting executions against poor performance

• Evidence that executions with MinQty outperform executions without MinQty is tepid and declines with an order’s urgency and willingness to be aggressive
• The cost in hit rate and order drift often outweighs any direct protection MinQty can provide

As such, MinQty should not be used as a generic defense tool

• It may not be an appropriate protection mechanism based on the trading context

That said, MinQty can act as a venue optimizer

• Venues show consistent post-execution performance characteristics
• Protective venues do not offer an infinite supply of liquidity

Therefore, using a lower MinQty on more protective venues and a higher MinQty on less protective venues provides balanced liquidity sourcing across available destinations

• How we use MinQty depends on how aggressively we want our algorithms to search for liquidity in a specific routing table and for that specific venue

Putting It All Together

IOC orders are similar to far touch orders in that MinQty does not seem to offer markout protection even though, on balance, zero MinQty orders tend to have higher expected markouts independent of execution.

Although hit rates drop substantially as MinQty increases, as in the case of all the limit types that we have reviewed, because of the short life cycle of IOC orders, there does not appear to be any significant opportunity cost to sending an IOC with a MinQty assuming that it is followed by a near simultaneous reload.

Applying These Findings

At Baird, we strive to provide the proper balance between efficient liquidity sourcing and market impact. MinQty settings are one of the tools that we use to achieve that balance. We also use liquidity segmentation to control counterparty interaction within a specific ATS, as well as specific differences in the routing tables themselves (where we route and how we route).

Specifically with MinQty settings, we do not use a “one-size-fits-all” approach. For venues that have built-in order protection, such as IntelligentCross, IEX D-peg, and Nasdaq M-ELO, we do not use MinQty. For standard ATSs, we adjust MinQty settings based on a number of factors such as toxicity scores, reversion, impact, urgency, etc.

Getting this formula right is not always easy. It is part art and part science. It takes a long-term data view and real-time (order-by-order) analysis. But as our tools become more robust, and our data analysis more detailed, we continue to gather the necessary intelligence to inform appropriate algorithmic adjustment decisions and to properly align client objectives with best execution results.

About Us

Baird: Established in 1919, Baird is an employee-owned, privately held wealth management, investment banking, asset management, and private equity firm with more than 200 offices and over 4,600 employees in the United States, Europe, and Asia. Baird has more than $300 billion in client assets worldwide. Since 2004, Baird has been recognized annually as one of the Fortune 100 Best Companies to Work For^®. Quality. Consistency. Partnership. Baird.

IntelligentCross: IntelligentCross operates two matching books in its ATS - INCR. Intelligent Midpoint works to actively minimize market response after trades. ASPEN (Adverse Selection Protection Engine) Bid/Offer book, is fine-tuned for posting passive liquidity. INCR matches roughly 25mm shares single counted per day. For more information please email info@intelligentcross.com.