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Mar 8, 2021

March 8, 2021

Breaking Down M-Peg and D-Peg

IEX Exchange offers two differentiated ways to access our midpoint liquidity.

Why does IEX have two separate midpoint-focused order types? As the largest U.S. equity midpoint exchange, IEX offers two differentiated ways to access our midpoint liquidity.

This piece will provide an overview of IEX’s key protections, the Speed Bump and Signal, and two midpoint-focused order types, Midpoint Peg (M-Peg) and Discretionary Peg (D-Peg). This will serve as an introduction for those looking to increase their midpoint trading on IEX and a reference for those already accessing the midpoint at IEX.

IEX Speed Bump & Signal

IEX’s foundational technologies, the Speed Bump and Signal, underpin the performance of the order types available on the exchange and are a key differentiator between IEX and other exchanges.

IEX Speed Bump

IEX’s most foundational and most well-known protection is the IEX “Speed Bump,” which is designed to ensure that the exchange executes trades at the most up-to-date price. We do this by implementing a 350-microsecond delay on all orders and other messages (e.g., cancellations) coming into the exchange. This allows IEX time to process market data changes from other exchanges and update our quotes to reflect those changes accurately before trades are executed.

For example, imagine Exchange A is setting the NBBO for a stock at $10.00 x $10.10, and you are a dark, pegged order on IEX resting at the NBB ($10.00). The Exchange A quote changes and the NBBO is now $9.99 x $10.09. A spread-crossing sell order comes in to IEX to sell to you at the NBB. Because of the Speed Bump, that seller goes through a 350-microsecond delay before being able to sell to you. Those 350 microseconds give IEX a crucial window of time to receive the message from Exchange A that the new NBB is $9.99 and move your order down to $9.99. Because of the Speed Bump, you buy at $9.99 and avoid trading after the NBBO change.

The Speed Bump is designed to help IEX protect Members from trading at stale prices once the quote has already changed. It is part of IEX’s core architecture, and therefore is incorporated in every order type on IEX.

IEX Signal

IEX has also developed the IEX Signal, a proprietary model that is designed to predict when a quote is likely about to change in a detectable way. Thanks to the 350-microsecond buffer afforded by the Speed Bump, IEX is able to make these predictions using the latest market data before trades are executed.

The Signal makes its predictions by examining the sequential quote updates from other exchanges to identify when there is a significant imbalance in the number of bids and offers. These imbalances indicate a high likelihood that the National Best Bid (NBB) is about to decrease or the National Best Offer (NBO) is about to increase. We refer to this imbalance as a “crumbling” or “unstable” quote. When the “unstable” quote determination is made, the Signal “fires,” or turns “on,” and then this Signal protection is incorporated into different order types at the exchange.

An example of a Signal fire goes as follows. Imagine you are a buyer of XYZ stock. There are 8 exchanges and four of them are currently showing a bid at the NBB and 4 are showing an offer at the NBO. Moments later, there is only 1 exchange at the NBB but 4 at the NBO. The Signal spots this imbalance of bids and offers and predicts that there is a very high likelihood that the next move will be the NBB going lower. This prediction prompts a Signal fire that is then incorporated into different order types.

Unlike the Speed Bump, the Signal is not part of IEX’s core architecture and is specifically incorporated into our “Signal Series” order types on the exchange, including D-Peg.

M-Peg Functionality

Midpoint Peg, or M-Peg[1], is a dark order type, pegged to the midpoint of the NBBO.

What differentiates M-Peg from midpoint pegs on other exchanges is the Speed Bump. By design, it is the responsibility of each exchange to manage the pricing of pegged orders resting there. Because all orders coming in to IEX must pass through the Speed Bump, IEX has that extra time to consume, digest, and incorporate quote updates from other exchanges before trades are executed. This is crucially important for pegged order types as the exchange has time to update the price of pegged order types so that they are based on the most up-to-date NBBO.

Having the most accurate pricing information allows IEX to reprice resting M-Peg orders (as well as other pegged orders) before a counterparty can interact with them at a stale midpoint.

M-Peg is considered a relatively aggressive order type on IEX because of its priority in the trading queue. As it is pegged to the midpoint, it will trade before all other order types priced less aggressively, including D-Peg (described in more detail below). M-Peg’s superior pegging ability (from the advantages of the Speed Bump) and midpoint pricing can make it an effective tool for Members, particularly in more aggressive strategies.

D-Peg Functionality

D-Peg is one of the most powerful order types at IEX, because it incorporates the protections of both the Speed Bump and the Signal.

D-Peg is a dark order type that is pegged one tick below the bid or above the offer and has discretion to trade to the midpoint. D-Peg incorporates the Signal by turning off discretion when the Signal is “on.” This prevents D-Peg orders from trading more aggressively when the Signal predicts the midpoint is likely about to change.[2]

As an example, imagine you are a buyer of 200 shares of stock XYZ which is trading at $10.00 x $10.10. You are resting at $9.99 and can trade up to $10.05, since the Signal has not fired.

  • A sell order of 100 XYZ comes in with a limit of $10.00. You exercise discretion to the bid and buy 100 shares from that seller at $10.00. You still have 100 shares in your order and remain pegged at $9.99.
  • Now, the Signal fires and for the next 2ms your discretion to $10.05 is turned off. During this 2ms, another sell order comes in with a $10.00 limit. You do not buy from this seller because your discretion is off.
  • Within 2ms, the stock price moves lower to $9.99 x $10.09. You are now pegged at $9.98 with discretion up to $10.04.
  • A seller comes in with 100 shares and a $10.04 limit and you exercise discretion to the midpoint to buy your remaining shares.
  • In summary, you bought 200 shares at an average price of $10.02.

This order achieved price improvement — a blended average of 3 cents pers share vs. the arrival midpoint — because of its ability to trade anywhere between the bid and mid, its ability to avoid trading when the Signal predicts the quote is unstable, and its ability to float with the quote.

IEX Midpoint Order Types vs. the Competition

Despite M-Peg and D-Peg’s differences to one another, IEX’s underlying design gives its order types an edge over other exchanges when it comes to trading in a stable market. While there is no specific definition of a “stable market,” at IEX we consider a trade to have been made in a stable market if it does not occur within 2ms of a quote change. From our vantage point, trading at the midpoint in a stable market leads to optimal execution.[3]

Below, we show that far less of IEX’s midpoint volume trades when the quote is unstable, or within 2ms of a quote change, compared to other exchanges. When looking overall or by price/spread bin, IEX maintains the #1 position for most stable midpoint volume versus the eight largest U.S. equity midpoint exchanges.

As Members implement M-Peg and D-Peg into their strategies, it is important to keep in mind that both order types exist in an ecosystem where protection and performance are top priorities.[4]

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Source: IEX Market Data. Date Range: 10/01/2020–12/31/2020. Please note that these categories are not inclusive of the upper bound and include the lower bound. For example, $0.02 is $0.02 to $0.04.
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Source: IEX Market Data. Date Range: 10/01/2020–12/31/2020.

Conclusion

IEX’s foundational design creates a differentiated experience on IEX compared to other exchanges. As traders have an increasing amount of order types and complex market structure changes to keep track of, we hope this primer can serve as a reference for IEX’s differentiated protections and how those work to enhance some of our popular order types.

[1] In this blog, when referring to M-Peg and D-Peg orders, we are only referring to resting orders. Both order types have the functionality to remove on entry, and IEX also has M-Peg and D-Peg IOC order types, but neither are part of this analysis.

[2] D-Peg’s use of the Signal aims to reduce the times a trade occurs between the NBBO and midpoint when the Signal is on. Since D-Peg orders are booked one tick less aggressive than the NBBO, when the Signal is “on” and discretion is off, D-Peg orders can still execute trades one tick outside the NBBO. Additionally, D-Peg orders have the ability to remove liquidity on entry and can remove liquidity even when the Signal is on.

[3] For more information on midpoint fills and market stability check out our blog posts: “Modern Day Latency Arbitrage: Predicting Price Changes,” “Examining Execution Stability at IEX” and “Who Ever Said Buy High and Sell Low?

[4] Note, D-Peg is much more heavily used than M-Peg on IEX and therefore more heavily represented in the data.

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