In April, Investors Exchange (IEX Exchange) rolled out the latest version (V6) of its unique predictive price model, Signal. With the latest iteration finally providing the exchange with enough data to analyse the effect of the Signal V6 on D-Peg and P-Peg orders, the firm spoke exclusively to BEST EXECUTION about how V6 ‘learns’ from the market, why transparency is key and how things have changed since the last update.
Designed to predict more price changes than V5, which hit the market in 2018, IEX Exchange says V6 enhances performance for pegged orders on the firm’s exchange, by looking at both size and number of venues (rather than just venues), and factors in the addition of three new US equities exchanges – MEMX, MIAX and Nasdaq PSX.
“V6 is more rules-based, a series of decision trees. There are nine rules and any one of the nine rules can turn on the Signal. It is what we call a crumbling quote indicator,” Matt Weinberg, head of business development at IEX Exchange, told Best Execution.
V6, thanks to its rules-based structure, constantly evaluates the effectiveness of each of the rules per symbol, explained head of business analytics Sam Stevens. If the Signal determines that based on recent historical accuracy that one of the rules is not performing or predicting effectively, it will automatically turn that rule ‘off’.
“The model is, in some sense, designed to be learning in a predefined way that everyone can follow and understand,” Stevens added. Likewise, if that rule starts to become effective again, it can be turned back on.
“The sort of conditions in the morning when spreads are wider and markets are moving a lot more might be different in terms of predicting crumbling quotes than at the end of the day, when there’s a lot more liquidity and tighter spreads,” Stevens said.
The firm’s crumbling quote indicator is a proprietary statistical predictive model that targets adverse price changes and powers IEX Exchange’s signature protective order types, including D-Peg and P-Peg, to react “advantageously” to unstable market conditions.
Originally built using standard logistic regression (V6 has now shifted to a rules-based model) and designed to forecast imminent adverse national best bid and offer (NBBO) price changes, the Signal has been operational since 2014.
Stevens said both the former logistic regression model and the new rules-based model are publicly filed with the Securities and Exchange Commission (SEC), so everyone understands what market conditions will turn on the Signal.
“It’s one of the reasons it was approved by regulators and it’s something that we really believe in having; a transparent model. We don’t want it to be this ‘black box’ where people don’t know when the Signal is firing and when it isn’t,” Stevens added.
The firm, which launched in 2012 in response to what founders Brad Katsuyama and Ronan Ryan considered the deleterious effects of latency arbitrage, is an exchange with a built-in ‘speed bump’ – a 350 microsecond delay. “That’s about 1/1000 of the time it takes to blink. We’re talking a very, very short time here,” Weinberg said.
This feature – unique at the time of inception but since adopted by other competitors – is designed to protect orders from latency arbitrage strategies by slightly delaying incoming orders from customers so that the stock exchange itself always has the most up-to-date pricing information.
The only thing that doesn’t go through the speed bump is IEX’s market data, which moves at 66% the speed of light through the fibre optic coil. This information is what IEX Exchange leverages to counter adverse price selection.
“The Signal was introduced because we were able to see aggressive orders coming in right before a quote was about to change,” Weinberg explains.
The firm has updated the Signal five times, the last being in May 2018. Since then, IEX Exchange released D-Limit, a new order type that incorporates the Signal. The firm said market conditions have also changed since 2018, pointing to the rise in retail trading and the surge in volatility during the Covid-19 pandemic, an increase in market volumes and the average number of NBBO quote changes.
In 2020, IEX Exchange sought approval from the SEC for the D-limit order it introduced that year, which was designed to protect liquidity providers from potential adverse selection resulting from latency arbitrage trading strategies, and to encourage members to submit more displayed limit orders to the exchange. Contested by market maker Citadel Securities, the approval was granted by the SEC in July 2022 which IEX Exchange at the time said was a “huge win for all investors.”
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