UPDATE: The SEC approved IEX Group’s request to launch a new public stock exchange after this story was published.
The Securities and Exchange Commission has until 11:59 p.m. Saturday to decide whether to approve a new stock exchange called IEX.
IEX is just like other stock exchanges, with one little difference.
“The IEX places a very small delay in how it processes orders,” explained Larry Harris, professor of finance at the USC Marshall School of Business.
Delay is, of course, a relative term. In this case the delay is 350 microseconds or 0.00035 seconds.
“The purpose of this delay is to frustrate high-frequency traders,” Harris said.
High-frequency traders are a type of super fast trader with better computers and faster connections. They can, in some cases, outmaneuver other traders.
For example, let’s say a big trader is placing a large order of stock. The high-frequency trader can notice this is happening, race in at light speed and get that same stock before the big trader is even done buying it. The stock price rises, the big trader may have to pay more for it, and either way the high-frequency trader makes money.
“And, of course, that’s not good for the market because we don’t like to see orders having a lot of price impact,” said Harris.
Even a teensy delay basically makes that kind of light-speed maneuvering impossible. That’s the value add for IEX. What could be the problem with that?
“The issue is if you’re forced to use it, and that I think is the controversy,” said John Jacobs, executive director of the Center for Financial Markets and Policy at GeorgetownUniversity. “What happens if the price is there, you’re forced to route to them, they have that speed bump in, and the price moves on some other venue before you get there?”
There are a lot of stock markets also trading shares without speed bumps. What if investors miss out on a good price while they’re waiting on that speed bump at IEX?
“It’s certainly a possibility,” said the Marshall School’s Larry Harris. “But we have to ask ourselves how often do we think this is going to happen?”
Harris said maybe not that often, and maybe the risk is worth it for a more level playing field.