Speaker 1: This is Masters in Business with Barry Ridholts on Bloomberg Radio.
Speaker 1: This week on the podcast, I have an absolutely fascinating conversation.
Speaker 1: My special guest is Keith Ross. He is the current
Speaker 1: CEO and chairman of p d Q Enterprises, which is
Speaker 1: a really interesting innovative automated trading system and dark pool
Speaker 1: that has a novel approach to getting X. I think
Speaker 1: it's novel. I don't know enough about dark pools because
Speaker 1: much of them are dark but his description of how
Speaker 1: they sort of put the auction process UH in an
Speaker 1: inverted form to obtain the best price and execution for
Speaker 1: their clients is quite fascinating. He has been in the
Speaker 1: front lines of high frequency trading for a long time.
Speaker 1: He used to be the CEO of get Go, sold
Speaker 1: for about a billion for to night Trading a couple
Speaker 1: of years ago, one of the biggest h f t
Speaker 1: s by volume. If you are at all a student
Speaker 1: of market structure, if you're interested in institutional execution, dark pools,
Speaker 1: h f t S algorithms, if you're a critic of
Speaker 1: h f t s as well, you will find this
Speaker 1: to be an informative and fascinating conversation. So rather than
Speaker 1: have me babil incessantly without any further ado. Here is
Speaker 1: my conversation with Keith Ross. This is Masters in Business
Speaker 1: with Barry Ridholts on Bloomberg Radio. My special guest this
Speaker 1: week is Keith Ross. Here's the chairman and CEO of
Speaker 1: pd Q Enterprises, a trading and finance firm. Previously he
Speaker 1: was CEO of get go Uh, one of the largest
Speaker 1: high frequency trading shops. Keith Ross, Welcome to Bloomberg. Thank
Speaker 1: you very much, Barry. Pleasure to be here. So so
Speaker 1: let's keep start out simple and will build in complexity
Speaker 1: as we go. First off, what is high frequency algorithmic
Speaker 1: trading and why should people care about it? Well, high
Speaker 1: frequency trading is just regular trading by computers instead of
Speaker 1: humans clicking a mouse. Computers handle everything from identifying the
Speaker 1: trade to executing it precisely, and it turns out I
Speaker 1: believe it's a it's a wonderful efficiency for our markets.
Speaker 1: Trading costs and commissions have come down dramatically over the years. Um.
Speaker 1: I know there's a lot of concern about the robots
Speaker 1: taking over the world, but um, the vast majority of
Speaker 1: high frequency traders are passive liquidity providers. So they are
Speaker 1: in the market virtually all the time, and we can
Speaker 1: talk about that in a little bit. But their goal
Speaker 1: is to capture spread the way market makers have done
Speaker 1: for centuries, and provide liquidity. So here's the here's the
Speaker 1: pushback on liquidity as always well, they like the banku
Speaker 1: who will lend you the umbrella when it's sonny out.
Speaker 1: They provide liquidly when it's not needed. But when things
Speaker 1: get very well, they just shut off the machines and
Speaker 1: step away from the market. So I want to respond
Speaker 1: to that and say it's actually a myth. Because a
Speaker 1: couple of folks were out loud about backing away from
Speaker 1: the market. The guys who knew what they were doing
Speaker 1: did not, And my understanding is they had very good days.
Speaker 1: So there's actually an incentive for them to stay in
Speaker 1: the market. With all that volatility and chaos, there's a
Speaker 1: lot of opportunity um and you know, those that are
Speaker 1: not as concerned about that would argue. And at other
Speaker 1: times in market chaos, market makers specialists didn't pick up
Speaker 1: the phone. That's the same problem. So you couldn't get
Speaker 1: to your broker. Maybe you wanted thought you wanted to
Speaker 1: do something, but you couldn't find anyone to take the
Speaker 1: other side. Again, I'll take the other side. Seven day
Speaker 1: was really a one off down. No one could get
Speaker 1: through to anybody. Let's talk about the flash crash, which
Speaker 1: is the modern version. So May ten, two thousand and ten,
Speaker 1: we saw a seven point practically instantaneous drop. What caused that?
Speaker 1: A lot of people insisted on blaming five frequency traders
Speaker 1: for that. Well, they're going to be the scapegoat because
Speaker 1: like the specialist in the old days, they're the ones
Speaker 1: that everyone believes are the operators in the market um
Speaker 1: and have that opportunity to either make the market or not.
Speaker 1: Both cases. The macro environment was very, very bearish, and
Speaker 1: so the question becomes, you know, what is the responsibility
Speaker 1: of the participants? Uh, they took time off and withdrew dramatically.
Speaker 1: The beautiful part about the flash crash to me is
Speaker 1: the following flash dash after a five second pause in
Speaker 1: the many futures, the whole market was able to recalibrate, reassess,
Speaker 1: and it was it was a hard event during the day,
Speaker 1: but it was over in an hour. It's funny because
Speaker 1: I was flying back from Dallas that day or somewhere
Speaker 1: in Texas, and I look at my screen when I landed,
Speaker 1: I'm like, that's got to be a mistake. And it
Speaker 1: was until I got in the cab and started speaking
Speaker 1: to my office that I found out what happened. We
Speaker 1: were down a thousand points. We closed down three, explained
Speaker 1: to me. So so that that's the big criticism UM
Speaker 1: in general. There are other criticism will get to later,
Speaker 1: but I want to set the table a little bit
Speaker 1: with what you currently do in some quotes of yours.
Speaker 1: Let me let me just start asking what is p
Speaker 1: d Q Enterprises and PDQ Trading actually do. So. P
Speaker 1: d Q Enterprises is the parent of p d Q
Speaker 1: A t S are broker dealer. We are a probably
Speaker 1: considered a dark pool, even though we believe we operate
Speaker 1: differently than all the others. We have a unique market structure.
Speaker 1: We can actually create liquidity on demand for orders, we
Speaker 1: can consolidate fragmented liquidity. And the beauty of our auction process,
Speaker 1: which is kind of the key aspect of why we
Speaker 1: are different, is that we can aggregate people with different
Speaker 1: time latency sensitivity. So whether the people who are either
Speaker 1: very high speed or high speed or normal speed correct
Speaker 1: all right, and how is PDQ different than your previous employer.
Speaker 1: Get Go, who is not too long ago sold to
Speaker 1: Night Trading, and at the time I think they still
Speaker 1: are one of the biggest h f T shops in
Speaker 1: the world. I believe they're one of the biggest traders.
Speaker 1: They did merge with night Um. I went from the
Speaker 1: liquidity providing side, which we were doing it get Go
Speaker 1: when I saw the PDQ opportunity. So the way PDQ works,
Speaker 1: an order comes to us and we pause it for
Speaker 1: up to twenty milliseconds. That sounds vaguely familiar, but in
Speaker 1: that time we do something very constructive for the order.
Speaker 1: What we do is we ping our liquidity providers with
Speaker 1: only the symbol and effectively bring back the question that
Speaker 1: used to be asked at the post of what is
Speaker 1: the market? So in other words, you don't say I'm
Speaker 1: buying a hundred thousands of selling a hundred thousand. You say,
Speaker 1: here's the symbol, what's your price, what's your best market?
Speaker 1: We have a dozen providers that are all responding. We
Speaker 1: can also include institutional passive liquidity providers, and we build
Speaker 1: a book and once we have the book, we take
Speaker 1: the instructions from our client to execute the order against
Speaker 1: the book. So we create competition for every order, and
Speaker 1: in this pause we're in position to take speed out
Speaker 1: of the equation. I'm Barry Ridults. You're listening to Masters
Speaker 1: in Business on Bloomberg Radio. My special guest today is
Speaker 1: Keith Ross. He is the CEO of PQ Enterprises, a
Speaker 1: rather interesting trading shop. Dark Pool goes by a number
Speaker 1: of different names. Keith, I want to start with a
Speaker 1: quote of yours and have you comment on it, and
Speaker 1: it goes something like this, there is nothing wrong with
Speaker 1: speed in any other industry. It's applauded. It's an efficiency
Speaker 1: discuss well. UM. One of my favorite examples is your telephone.
Speaker 1: Back in the day, we had telephone operators pulling cables
Speaker 1: and plugging them into the wall to connect you to
Speaker 1: your call. And today we have cell phones that are
Speaker 1: many computers and you can do everything on your phone.
Speaker 1: Incredible technology advancement proficiency. I haven't heard in the early
Speaker 1: days of of UM cell phones there were connection issues,
Speaker 1: but those have gotten so much better. You know, it's
Speaker 1: all about how many megabytes of upload and download and
Speaker 1: so forth. I believe the same things happened for trading,
Speaker 1: so spreads have gotten tighter, commissions have come down dramatically,
Speaker 1: the cost of execution and has never been lower. Um
Speaker 1: I think it was. Vanguard in two thousand and ten
Speaker 1: said our portfolios due to electronic trading have a one
Speaker 1: percent per annum increase in return. Given the fact that
Speaker 1: they're pension problems across our whole country. Anyone that's involved
Speaker 1: with the retirement programmer has pension money working in the
Speaker 1: marketplace is a beneficiary of a more efficient market. Jack Brennan,
Speaker 1: who's now chairman emeritus of Vanguard, when we spoke with him,
Speaker 1: he said something along those lines. But let me give
Speaker 1: you the pushback from the other side. Hey, h f
Speaker 1: T firms are taking out billions of dollars a year
Speaker 1: in profit. Trading is essentially a zero sum game. That
Speaker 1: profit has to be coming from somewhere, and it's coming
Speaker 1: from grandma's retirement account. Would actually vehemently disagree on almost all.
Speaker 1: I would hope you would disagree. Tell me why that
Speaker 1: description is an error, and I sort of have a
Speaker 1: foot in that camp that that makes some sense to me. Okay,
Speaker 1: first of all, let's start with the zero sum game problem.
Speaker 1: The capital markets are not zero sum the capital markets
Speaker 1: can create wealth and wealth can be destroyed in them.
Speaker 1: So I have a good friend, what's a thousand shares
Speaker 1: of apple for each of his kids? He sold it
Speaker 1: in two thousand and ten, he made times his money
Speaker 1: wealth creation. Anyone who's bought an apple product knows apple
Speaker 1: stock has gone to the moon. So that's not zero sum.
Speaker 1: But what happens if he goes to sell it and
Speaker 1: instead of selling that at a hundred one dollars and
Speaker 1: fifty cents, he only gets a hundred one dollars and
Speaker 1: five cents because someone jumped in the middle of his execution.
Speaker 1: So there could be that could be an issue. I
Speaker 1: don't think that it is, because in the old days
Speaker 1: it would have been a twenty five or fifty cent bid,
Speaker 1: a nickel much bigger. So you're talking commission, not spread.
Speaker 1: So in other words, the tradeoff is it used to
Speaker 1: be higher commissions and wider spreads, and now the spreads
Speaker 1: are tighter, the commissions are smaller, and if there's an
Speaker 1: execution charge that finds its way into this net net,
Speaker 1: it's still better for the UH traders that retail has
Speaker 1: never had it better. Bill McNabb, current chairman and CEO
Speaker 1: Vanguard and also a former guest on Mester's business. He
Speaker 1: said something very similar, and I was more vehemently questioning
Speaker 1: when I keep reading and hearing about market structure, and
Speaker 1: when I get a guy like McNabb saying, hey, you
Speaker 1: know this has made our trading costs lower, it forced
Speaker 1: me to at least rethink, well, now I have to
Speaker 1: take this with a grain of salt because he's got
Speaker 1: zero incentive to say anything. But what what is true
Speaker 1: true for Vanguard? So let's move to the other issue
Speaker 1: I always hear about, which is the front running. If
Speaker 1: somebody sniffs out what my order is and rather than
Speaker 1: executing that order, runs ahead of me, buys it and
Speaker 1: sells it back to me for whatever, and if we're
Speaker 1: petting higher cunitively, isn't that a huge drag on total
Speaker 1: returns for everybody? In the end, it's incredibly small relative
Speaker 1: to the markets to begin with. Second of all, the
Speaker 1: person doing that, the person the HFT that takes out
Speaker 1: the penny up offer, that's some price improvement for that guy,
Speaker 1: so he's a happy guy. The seller is paying a penny,
Speaker 1: is getting a penny more than they might have. I'm
Speaker 1: just saying that's certainly a possibility that's never talked about,
Speaker 1: that it's price improvement for a contra party. Certainly, the
Speaker 1: sniffing ability is only an educated guess, just the way
Speaker 1: people used to do in the market back in the day.
Speaker 1: So they can't see the order. That's a that's a myth.
Speaker 1: And the models understand supply and demand and they're trying
Speaker 1: to find that balance between supply and demand all the time.
Speaker 1: All of a sudden, if there's a big demand, the
Speaker 1: supply is gonna move their price higher. So, um, it's
Speaker 1: much ado about nothing in my opinion. And what I'll
Speaker 1: do is, I'll say this, most of the people that
Speaker 1: talk about that don't understand that liquidity provision is a service. Okay,
Speaker 1: So there to me, there's this mythical idea that when
Speaker 1: a trade takes place, the buyer and seller have this
Speaker 1: come bay, let's hold hands moment and exchange our whatever
Speaker 1: security is at whatever the price is, which is fine
Speaker 1: at the moment of the trade, but one tick later
Speaker 1: one of the parties has been disadvantaged. And when I
Speaker 1: was on the floor, used to trade with people and
Speaker 1: you'd confirm and you'd smile, and you'd say thank you,
Speaker 1: and then one second later you'd say, that's of a gun,
Speaker 1: he just picked me off, right, because the tick went
Speaker 1: agains well, But that's after the fact. You know, once
Speaker 1: the market moves either in your favor against you. Hey,
Speaker 1: that transaction is done, you can't blame the guy that
Speaker 1: you bought something you shouldn't or sold something too early.
Speaker 1: That it's it's you know, after the transaction is done.
Speaker 1: It's pre transaction or during the transaction that I think
Speaker 1: some people are are complaining about. Certainly UM. The counter
Speaker 1: argument to that was explained extremely well in Uh, a
Speaker 1: book by Covic. I believe Peter Kovic uh Flashboys Not
Speaker 1: so Fast. It was the the antidote to Michael Lewis.
Speaker 1: I'm Barry Ridhults. You're listening to Masters in Business on
Speaker 1: Bloomberg Radio. My special guest today is Keith Ross. He
Speaker 1: is the CEO of PDQ Enterprises, a trading dark pool
Speaker 1: as well as a broker dealer that Correct and Ats
Speaker 1: was formally CEO get Go, which is now part of
Speaker 1: Night Training and is one of the largest h f
Speaker 1: T s in the world. Let's talk about Michael Lewis's
Speaker 1: book Flashboys, which I read on vacation and found to
Speaker 1: be a couple of summers ago and found to be
Speaker 1: an entertaining romp that raised all sorts of questions about
Speaker 1: market structure. But I have heard that you didn't think
Speaker 1: it was especially accurate. Well, I actually wrote a review
Speaker 1: of the book the day after it came out, so
Speaker 1: I got it on mike Kindle and read it electronically overnight.
Speaker 1: Fascinating story. I'm a Michael Lewis fan. He writes great novels.
Speaker 1: But it's a novel. So the problem, the issue that
Speaker 1: I have is it's the story of Brad Katsiama, which
Speaker 1: is a fun story, terrific guy, really another guest on
Speaker 1: the show, absolutely and endlessly entertaining story is as told
Speaker 1: by Michael Lewis, and it helped me dramatically. There's a
Speaker 1: YouTube interview between Michael um glad Well. It's not Michael Gladwell.
Speaker 1: Malcolm Gladwell and Michael was a seventy minute love fest
Speaker 1: between the two of them. And what helped me the
Speaker 1: most was when Michael Lewis explained what I do is
Speaker 1: I find a person I'm interested in and I write
Speaker 1: their story, which is exactly what he did in the book.
Speaker 1: My issue is as a treatise on market structure, he
Speaker 1: never talked to any of the exchanges, any of the
Speaker 1: other a t s s, any of the high frequency traders,
Speaker 1: any of the electronic algorithm people that are in the business.
Speaker 1: So it's one view from one person, and I don't
Speaker 1: think it's a whole picture of the marketplace. So Lewis
Speaker 1: and Katsuyam were on sixty minutes, came out and said
Speaker 1: markets are rigged. Yes, the markets are rigged, and it
Speaker 1: it's a perfect headline. It's the perfect marketing way to
Speaker 1: get your book sold to hundreds of thousands of people.
Speaker 1: The issue is if you listen or read the book,
Speaker 1: what they really said was it's possible that the execution
Speaker 1: of an order in the marketplace is rigged. Later on,
Speaker 1: when Michael Lewis was asked you invest in the stock market,
Speaker 1: he says, oh, yeah, I've on dtfs for years and years.
Speaker 1: My family has always been an investor. So when the
Speaker 1: market is rigged, that headline screams it's a three card
Speaker 1: Monty game, there's no way you can win. Absolutely untrue.
Speaker 1: By your apple twenty years ago, you're a happy guy today.
Speaker 1: So that nuance is totally lost. In a sixty minutes piece,
Speaker 1: the world was in a tizzy. It appeared that the
Speaker 1: high frequency guys were making a lot of money. They
Speaker 1: had a two, but they're not making that much money anymore.
Speaker 1: Volumes have just completely dried up. And volumes have dried up.
Speaker 1: Let me share a quick story around efficiency that I
Speaker 1: like to tell. If you buy or sell a house,
Speaker 1: five percent commission. When you go to Starbucks and buy
Speaker 1: a latte with your credit card, you pay Master Carter
Speaker 1: visa three percent commission on a three dollar latte, So
Speaker 1: that's nine cents. If you trade three shares of Starbucks
Speaker 1: and you're an electronic market maker, they make about three
Speaker 1: cents per hundred, so they're gonna make the same ninth
Speaker 1: sense that you're gladly play Visa for your latte. And
Speaker 1: yet they're going to trade dollars worth of stock and
Speaker 1: take risk while they're doing the trade. Their margins are
Speaker 1: so infinitesimally small. There's no other capital transaction anywhere that
Speaker 1: comes close to that type of efficiency. So my colleague
Speaker 1: Josh Brown likes to say the people complain that high
Speaker 1: frequency trading uh and the markets are rigged. His responses
Speaker 1: the markets have always been rigged. There's always been a specialist.
Speaker 1: There's always been somebody taking the pound of flash. At
Speaker 1: least today we know who would is. Again, I'll go
Speaker 1: back to my comment earlier that liquidity provision is a service.
Speaker 1: If you want to be able to trade and transfer
Speaker 1: risk whenever you want, someone needs to stand there and
Speaker 1: take the other side. The way money has always been
Speaker 1: made in the markets is to capture spread between the
Speaker 1: bid and the ask. That's done very quickly now and
Speaker 1: very scientifically. So it's not that the game has changed,
Speaker 1: just the players have changed. So in the last thirty
Speaker 1: seconds or so that we have what do you think
Speaker 1: of I e X that's the shop that Bradcotts Yam
Speaker 1: opened up. What do you think of their proposal to
Speaker 1: actually becommon exchange as an A T S. I applaud
Speaker 1: them and appreciate their innovation as an exchange, their protected
Speaker 1: quote hidden behind the delay could be very problematic. And
Speaker 1: my concern is other exchanges imitate I e X if
Speaker 1: they start to get market share, and we would have
Speaker 1: the situation of quotes that are not valid because they're
Speaker 1: being canceled, but no one knows because the cancel is
Speaker 1: going through the speed bump. This is Masters in Business
Speaker 1: on Bloomberg Radio. I'm Barry Ridhalts. My special guest today
Speaker 1: is Keith Ross. He is the CEO of PDQ Enterprises
Speaker 1: on a T S dark Pool, And there are all
Speaker 1: sorts of other technical terms we can discuss. So earlier
Speaker 1: we were talking about how market structure has changed. One
Speaker 1: of the claims about issues with high frequency trading is
Speaker 1: that it has introduced new systemic risk into the markets.
Speaker 1: True or false, it's got to be true. Systemic risk
Speaker 1: is very hard to understand and know. UM. But there's
Speaker 1: always been systemic risk, So it's not as though it
Speaker 1: didn't exist before. Electronic trades just different today and it's
Speaker 1: just a different fashion. UM. I think the regulators actually
Speaker 1: actually after the flash crash with UH some of the
Speaker 1: things they put in place limit up, limit down, UM
Speaker 1: attempting to get the venues to synchronize with each other.
Speaker 1: UM are certainly going to go help us move forward
Speaker 1: to create confidence in the market structure. UM, but systemic risk. Interestingly,
Speaker 1: to me, during the crash, none of the listed and
Speaker 1: cleared futures options or stock exchanges had any issues. It
Speaker 1: was only the over the counter trades where there wasn't
Speaker 1: a central counterparty. The central counterparty is the to me,
Speaker 1: the lynchpin of creating eliminating systemic risk, and Dodd Frank
Speaker 1: all seven hundred whatever pages of it should be one page.
Speaker 1: Everyone has to centrally clear their trades, no matter what
Speaker 1: they are, through some exchange, through an exchange, or a
Speaker 1: third party, because then the third party manages the risk
Speaker 1: and and they know where all the risk is from
Speaker 1: all the participants. That's that's interesting. So let's talk a
Speaker 1: little bit about that structure in some um greater detail.
Speaker 1: At one point in our history, the exchanges, the New
Speaker 1: York Stock Exchanged, other exchanges were really almost public utilities.
Speaker 1: They were not for profits. We eventually run into trouble
Speaker 1: with compensation and other issues under Dick Rasso. There was
Speaker 1: that whole digression. What should the proper role of the
Speaker 1: stock exchange be in modern trading? Well, let's it should
Speaker 1: be risk transfer among consenting parties. And so besides the
Speaker 1: risk transfer process, which is the matching of the trade,
Speaker 1: you also want to know that it's going to clear properly.
Speaker 1: If you're a buyer, you're going to get your securities.
Speaker 1: If you're a seller, you're gonna get your money. So
Speaker 1: it's the first step in a chain of several events
Speaker 1: that worked lawlessly through the financial crisis. For the list
Speaker 1: that exchanges, the the issue was in the over the
Speaker 1: counter credit swaps and some of those issues where everyone
Speaker 1: became suspicious of their counterparties required more margin, and companies
Speaker 1: that had tens of billions of dollars two weeks later,
Speaker 1: we're needing to be rescued. So when I was coming up,
Speaker 1: we had the AMMAX, the Nasdack, the New York Stock exchanged.
Speaker 1: Today there's twelve exchanges, almost fifty dark pools, maybe even more.
Speaker 1: I have you lose track of forty is probably a
Speaker 1: better Okay, so forty plus dark pools. What about this fragmentation?
Speaker 1: What does this mean for getting orders executed? I've spoken
Speaker 1: to traders who have complained they go out to buy
Speaker 1: five or ten thousand shares. I don't need a hundred
Speaker 1: or five hundred, and they get forty seven here and
Speaker 1: a hundred twenty two there, and it takes a dozens
Speaker 1: of orders to get what used to be a simple
Speaker 1: transaction filled. What is this fragmentation and mean for for
Speaker 1: execution and structure? So too. Two parts to that answer. UM,
Speaker 1: One is it actually is redundancy if you look at
Speaker 1: it a different way. So a little while ago, this
Speaker 1: New York socket exchange was down for four hours. No
Speaker 1: one even new right, So that's actually a good thing.
Speaker 1: So you know, we get a start for that. Um
Speaker 1: the difficulty with the fragmentation. So the generic answer would
Speaker 1: be innovation. Innovation has come through a t S S
Speaker 1: has forced the stock exchanges to compete with each other again,
Speaker 1: has driven costs down, taking a lot of people out
Speaker 1: of the equation. There used to be many more bodies
Speaker 1: on the floor and on trading. Really it's it's going traumatically.
Speaker 1: It used to be like eight rooms. I think they're
Speaker 1: down to one room. It's a it's a that's right,
Speaker 1: it's a it's a television front. But here's how you
Speaker 1: solve that problem. If you have a structural pause, that
Speaker 1: can do good things for the order at PDQ, we
Speaker 1: can consolidate orders from other venues. So let's talk about that.
Speaker 1: So the complaint that some people have raised about I
Speaker 1: X CATSI Yamas Shop is that they introduced the speed bump.
Speaker 1: It's eight miles of coiled fiber. Optiction is right right,
Speaker 1: So that that introduces I'm doing the soft top of
Speaker 1: my head about a three and fifty micro second delay,
Speaker 1: so that nobody is disadvantaged by faster speed. It's still
Speaker 1: crazy fast, but that prevents what we talked about earlier,
Speaker 1: the front running, the picking off orders. Your twenty micro second,
Speaker 1: it's actually millisecond. Okay, speed guys, right, So that's a
Speaker 1: that's a longer delay. In other words, all right, so
Speaker 1: this is a twenty miller as opposed to three micro
Speaker 1: second delay that similarly forces is everybody uh with the
Speaker 1: speed advantage, or you're going to them on the lion
Speaker 1: making them compete for the order. We reverse the flow,
Speaker 1: so I e X. All they do is it's a
Speaker 1: speed bump for people to get in and out. It's
Speaker 1: it's like a turnstile at a door, right, everyone has
Speaker 1: to stop and go through the turnstyle. They've made an
Speaker 1: effective business out of convincing people that that's helpful. I
Speaker 1: think it's more helpful if you take that pause, share
Speaker 1: the symbol only. This is an incredibly important part of
Speaker 1: the equation, not the volume, not the product, the side,
Speaker 1: the size, or the price, and ask that question, where
Speaker 1: is the market in apple the high frequency folks, the providers,
Speaker 1: the institution, anyone who wants to provide liquidity then has
Speaker 1: to respond with a committed order. That committed orders aggregated
Speaker 1: into a book, and then that book is used to
Speaker 1: get to pick the best price and size exactly. That
Speaker 1: sounds like a really interesting innovation to deal with questions
Speaker 1: of of structure and fragmentation. You're actually taking advantage of
Speaker 1: the fragmentation. Well, we're consolidating it in this process. And
Speaker 1: interesting to me, I mean, I think it's somewhat ironic
Speaker 1: that this process replicates the way the floor used to
Speaker 1: work for the way an active pit would work in Chicago.
Speaker 1: Let's say, so let's talk a bit about order flow.
Speaker 1: What do you think about the payment for order flow?
Speaker 1: That's been a somewhat controversial issue. I have no issue
Speaker 1: with it. And let me explain why. Uh, just over
Speaker 1: a year ago conference in New York, five different by side,
Speaker 1: excuse me, five different retail brokers on the day as
Speaker 1: talking about their experience with their wholesalers to say it
Speaker 1: was a love fest as an understatement, every single person
Speaker 1: this is schwab and a merritory aid, and um, I'm
Speaker 1: trying to remember some of the other scott trade. Maybe
Speaker 1: it wasn't interactive brokers, but who's who of retail said,
Speaker 1: here's what our wholesalers do. They help us build our infrastructure.
Speaker 1: They the metrics that we track with them in terms
Speaker 1: of present price improvement, quality inside the spread, uh, quickness
Speaker 1: of response, number of trades that they don't feel to
Speaker 1: get sent out to the marketplace, that met all those
Speaker 1: metrics have gotten better over time. This was in I
Speaker 1: believe January. They're thrilled. Payment for order flow is just
Speaker 1: a different way of giving that spread capture to the dealer.
Speaker 1: Commissions have collapsed for retail folks. All you can eat
Speaker 1: on a trade, I mean it's virtually nothing. Go to
Speaker 1: a website called robin Hood and trade for free actually
Speaker 1: is zero cost. I assume it's built in somewhere in
Speaker 1: a moll. You know. Everybody will capture the spread on
Speaker 1: those trades, which is fine. But to the consumer it
Speaker 1: looks like a free trade, which is fine. So so
Speaker 1: let's talk. I would be remiss if we did not
Speaker 1: discuss spoofing, which the concept of cranking out tens of
Speaker 1: thousands of what some people call phantom orts that are
Speaker 1: never intended to be executed and then immediately canceling those
Speaker 1: which appears to be intended to manipulate markets to some degree.
Speaker 1: Why in a normal market would we ever need something
Speaker 1: like spoofing? Why would you ever bluff in a poker hand? Well,
Speaker 1: you bluff once, but you don't bluff ten thousand times
Speaker 1: in a micro second. Seems like a lot of bluffing
Speaker 1: going on. Yes, I'm being somewhat facetious. It's one person's bluff,
Speaker 1: maybe another person's brilliant move um or defensive move. But
Speaker 1: interesting to me that when the Commission decided to focus
Speaker 1: on these issues, and when you say commission you mean
Speaker 1: the SEC. The SEC and Finrie both creating rules around
Speaker 1: these types of events. They have yet to actually defined
Speaker 1: spoofing or layering, But what they did define over a
Speaker 1: year ago was disruptive trading. And I think that's much
Speaker 1: easier to focus on because it doesn't necessarily imply intent.
Speaker 1: So spoofing implies intent. I wasn't really meaning to trade,
Speaker 1: But if you've put those orders in, and there's so
Speaker 1: many risk parameters in place for you to put those
Speaker 1: orders in, meaning you've got to have enough capital in
Speaker 1: case you get killed that you can do the trade.
Speaker 1: It's a matter of debate whether they're spoofing or not.
Speaker 1: What's the actual intent. It's really really hard to define
Speaker 1: and certainly going to be very hard to prosecute someone.
Speaker 1: So if we people who are listening are intrigued as
Speaker 1: I am by h F T and algorithmic trading, if
Speaker 1: they wanted to find out more about p d Q,
Speaker 1: where's the best place for them to learn? P d
Speaker 1: Q A t S dot com p d Q A
Speaker 1: t s dot com. We have been speaking with Keith Ross.
Speaker 1: He is the chairman and CEO of p d Q Enterprises. UH.
Speaker 1: If you would like to learn more about this, you
Speaker 1: can check out the website p d Q A t
Speaker 1: S dot com. Be sure and check out my daily
Speaker 1: column on Bloomberg View dot com or follow me on
Speaker 1: Twitter at Riolts. I'm Barry Ridholts. You've been listening to
Speaker 1: Masters in Business on Bloomberg Radio. All right, welcome back
Speaker 1: to the podcast. Keith Keith I want to call you
Speaker 1: Donald keith Um. Thank you so much for doing this.
Speaker 1: This is really fascinating stuff. I know we are deep
Speaker 1: in the wonky weeds for the average listener, but trust
Speaker 1: me when I tell you there is an intense audience
Speaker 1: for this conversation. And I know I'm going to get
Speaker 1: all sorts of email, one half of which is gonna
Speaker 1: be saying, hey, the anti h f T guys, are
Speaker 1: you know vociferous? It was good you had a guy
Speaker 1: like he threw us on. And then the other emails
Speaker 1: are going to be and by the way, the first
Speaker 1: group will say, but you were a little rough on him,
Speaker 1: And then the other group are gonna say, hey, man,
Speaker 1: you let Keith r Us just get away with murder.
Speaker 1: You should have asked him. So let me go over
Speaker 1: some of the questions that they're gonna they're gonna ask
Speaker 1: us about. I think at this point in time, most
Speaker 1: people know what co location means. The servers at the
Speaker 1: various exchanges that people fight to be the closest one
Speaker 1: to the end of the run so that there's that
Speaker 1: little speed advantage of ten ft at the speed of light.
Speaker 1: How important are things like co location to h f
Speaker 1: T firms? Actually there, they probably created the whole idea
Speaker 1: in terms of doing it electronically. Co location and position
Speaker 1: in the pit years ago was also incredibly important, and
Speaker 1: people would get up at four am to make sure
Speaker 1: they had their spot next to their favorite broker so
Speaker 1: they could deal with him and trade his flow. So
Speaker 1: it's not new, it's just got a different shape. And
Speaker 1: it fascinates me that now that orders are done and
Speaker 1: completed in milliseconds and micro seconds, essentially, the world seems
Speaker 1: to be displaced by it. Where it used to take minutes,
Speaker 1: if not hours, to get a trade done, and it
Speaker 1: didn't seem to be an issue. So we went from
Speaker 1: hand gestures to software right to software. Operating at high speeds,
Speaker 1: many of the venues measure their cables so that everyone
Speaker 1: has the virtual same distance to the matching engine. So
Speaker 1: the CME does that, I know for sure, and it's
Speaker 1: an f it's in an effort to try to level
Speaker 1: the playing field. If you're in the co location, well,
Speaker 1: if you're not, you're a disadvantage, which is why they
Speaker 1: could charge big rents for those wrecks. And so for
Speaker 1: the high speed guys, the reason they need to co
Speaker 1: locate is they have to compete with each other. They're
Speaker 1: sho works fighting over anything that might be there, and
Speaker 1: they're very worried that if they're too slow, they're going
Speaker 1: to be the victim. This is a giant arms race
Speaker 1: is what's what's actually happen. So let's let's go through
Speaker 1: some of these other favorite terms. What is packet sniffing.
Speaker 1: It's an attempt to decipher what's in a message in
Speaker 1: a network, meaning in this context, to figure out what
Speaker 1: what might actually be the size and price of an
Speaker 1: order in order to get ahead of that line. It's
Speaker 1: not it's not clear to me that you can actually
Speaker 1: see what the order is, but you can see that
Speaker 1: maybe an order is coming. So I was always in
Speaker 1: the impression that since since every once the order goes
Speaker 1: into the exchange and the exchange exchange pings out to
Speaker 1: see what the best prices, once that happens, the h
Speaker 1: f t s have full access to it, and if
Speaker 1: they could beat everybody else to go by the order
Speaker 1: and fill that at a lower rice, they're allowed to
Speaker 1: do that. They're not the broker, so they don't have
Speaker 1: front running rules that apply to them. They're just a
Speaker 1: liquidity provider. And they're faster and getting if this is
Speaker 1: available for seven cents, and I'm going to turn around
Speaker 1: and flip it for eight cents. If they're faster than
Speaker 1: other guys doing that, they get to pocket that penny
Speaker 1: once it gets posted at the matching engine or at
Speaker 1: the venue. The matching engine would be actually executing a
Speaker 1: match once it's posted and everyone can see it. I
Speaker 1: think you know it's fair gets declared in fair game. Absolutely. Um.
Speaker 1: I was aware that in the future's world, some folks,
Speaker 1: we're putting one lots into the marketplace, meaning one futures contract,
Speaker 1: so the equivalent of one share of stock of order
Speaker 1: or it's like twenty or thirty dollars principle amount for
Speaker 1: a one lot, because the futures are leveraged. And now
Speaker 1: then going on the other side with the order, well,
Speaker 1: know what they did was they'd leave it in the
Speaker 1: marketplace until they got to fill. And at the time,
Speaker 1: the mechanics behind reporting the fill was quicker than changing
Speaker 1: the quote, so the phil would tell them that the
Speaker 1: quote was changing, so in other words, they would get
Speaker 1: filled before the quote would even show up and micro
Speaker 1: seconds nobody actually knows this report. I believe that's been
Speaker 1: sequenced so that it's everyone gets the information at the
Speaker 1: same time. But there was an opportunity. Oh, I see
Speaker 1: exactly what you're saying. So if you're filled before the
Speaker 1: quote moves, you know, the quote's gonna move right, so
Speaker 1: you have an information, so you have a chance to
Speaker 1: just because you were executed, and that's considered public, so
Speaker 1: everyone should have access to that. This doesn't get complicated
Speaker 1: enough of it. So so we talked about spoofing. What
Speaker 1: about quote stuffing, which is a term that I just love.
Speaker 1: What is quote stuffing? Well, it's an attempt to overwhelm
Speaker 1: the quote system so that people can't really understand where
Speaker 1: the market is. And is that considered manipulation or is
Speaker 1: there I would expect the SEC to use their disruptive
Speaker 1: Trading card and say you were trying to disrupt trading.
Speaker 1: This doesn't make sense. You know, you're fined or whatever.
Speaker 1: The results do we still see the sort of quote
Speaker 1: stuffing that was pretty common. I'm away from being on
Speaker 1: the front line the way I used to be at
Speaker 1: get go Um. Everyone is so fast and so on
Speaker 1: top of their game, so to speak. I would think
Speaker 1: it would be extraordinarily difficult now. But I can't say
Speaker 1: that it doesn't happen. I don't know for sure. You
Speaker 1: would think if someone is jamming a lot of quotes
Speaker 1: in order to cause confusion in the marketplace, that does
Speaker 1: make sense for the sec to want to stop that absolutely,
Speaker 1: and most venues, including PDQ, have limits on the number
Speaker 1: of orders on the same side and a given security
Speaker 1: that anyone client can send, so that if we see
Speaker 1: more than a couple of orders in one second, same side,
Speaker 1: same price, same um customers sending the order, that's problematic.
Speaker 1: It pops up on our compliance and we can check
Speaker 1: them out and make sure that they're not going Now
Speaker 1: is that going to be an automated interrupt or is
Speaker 1: that get kicked out with an email to somebody in
Speaker 1: a week later or someone So we're not the broker
Speaker 1: dealer of record, so it's up to us to inform
Speaker 1: the broker dealer and then it's up to him to
Speaker 1: decide what to do with it. So this won't be
Speaker 1: stopped at the point of contact. This is Hey, this
Speaker 1: person is abusing the system, and eventually they get kicked out.
Speaker 1: We have the capability to turn them off. I mean
Speaker 1: we've are compliance systems are in sync enough that we
Speaker 1: could if we needed to. UM we'd prefer to have
Speaker 1: the broker deal it do it because they know exactly
Speaker 1: where the client is and what the clients expectation, and
Speaker 1: they have the compliance over sure to do that. That
Speaker 1: that makes some sense. Um, walking away? What is walking away? Well,
Speaker 1: this is what we talked about earlier in terms of
Speaker 1: turning off your system. UM. I'd like to share an
Speaker 1: urban legend. There was a person writing a book interviewed
Speaker 1: a prominent high frequency trader who said, off the record,
Speaker 1: I recall this, I promise, off the record, we turned
Speaker 1: our machines off during the flash crash. During the flash crash,
Speaker 1: Um the reporter decided to put it on the record.
Speaker 1: The world assumed that everyone turned off their machines and
Speaker 1: walked away, and we're not making a market, when in fact,
Speaker 1: I know a lot of good firms took advantage, literally
Speaker 1: took advantage of the opportunity and made a lot of money.
Speaker 1: Anytimes volatility, if you so. I began my career as
Speaker 1: a trader, and one of the things I used to
Speaker 1: love to do. This is a hundred years ago and
Speaker 1: I'm sucking manually. This is brightly algorithms. I would leave
Speaker 1: a bid out a quarter or half a point under
Speaker 1: the market, and every now and then you got something,
Speaker 1: you get filled and it was just quick, you know,
Speaker 1: with one handed flick you turn around and sell it
Speaker 1: at the bid, Hey I sold a thousand shares a
Speaker 1: quarter point higher, it was free money. Now eventually that
Speaker 1: sort of nonsense stopped in the lad Or nineties, but
Speaker 1: I was astonished occasionally, Hey here's two for free. Um
Speaker 1: I had a friend who said, why don't we write
Speaker 1: a program to do that automatically? So they tried, and
Speaker 1: it made some money for about a month, and then
Speaker 1: that stuff just kind of dried up. So I look
Speaker 1: at that as an early h f T sort of
Speaker 1: thing and an arms race where the other side eventually
Speaker 1: nobody likes getting picked off for a quarter point constantly
Speaker 1: at a certain certain point they basically say you can't
Speaker 1: do this, or they just figure out, let's look at
Speaker 1: all the quotes and make sure that we're in the
Speaker 1: market and not now, if it's a buck outside of
Speaker 1: the market, that trade gets broken, but a quarter point
Speaker 1: in a fast moving market, but nobody's gonna care about that,
Speaker 1: so um or walk away from that. So so, given
Speaker 1: all these things, given everything that we have learns um
Speaker 1: is it's let me ask this in an open ended question.
Speaker 1: There was a lot of storm un drang and a
Speaker 1: lot of upset about h f T s a few
Speaker 1: years ago Certainly, as closer we get to the flash
Speaker 1: crash six years ago, the more people are upset. Is
Speaker 1: it that we've forgotten about the flash crash and these
Speaker 1: fears have faded? Has the market structure and the oversight improved.
Speaker 1: Has everybody kind of figured out, Hey, this technology thing
Speaker 1: is going to be here for a while. What's changed
Speaker 1: in the past five or six years that have kind
Speaker 1: of made the general outrage over h f T sort
Speaker 1: of settled down? I don't know if I'm asking that question.
Speaker 1: I think I get it. I mean it has dampened
Speaker 1: down quite a bit. Um. I think several factors. One
Speaker 1: is the stock markets much higher than it was five
Speaker 1: years ago. It's recovered dramatically, so so people look at
Speaker 1: their four oh one K and they don't have to
Speaker 1: jump out the window anymore. So that just in general,
Speaker 1: that helps a lot for people to feel better about
Speaker 1: the market. Um, the markets have put in some more
Speaker 1: rules and regulations, so we expected to behave better and
Speaker 1: I think it has. Um people are becoming more comfortable.
Speaker 1: So five, six, seven, eight years ago, people wouldn't even
Speaker 1: go online to do banking because they were anxious about security. Sure,
Speaker 1: people afraid to buy from Amazon. If you go back
Speaker 1: far enough, I can't I can't buy some put a
Speaker 1: credit card over the internet. Now, if you don't do it,
Speaker 1: you know you're you're not part of the world in
Speaker 1: which we live exactly. So all those things have changed. Um,
Speaker 1: the proper structure gotten better. Do you think the market
Speaker 1: structure is less precarious, more stable, less likely to be
Speaker 1: subject to another flash crash like event. I think it's
Speaker 1: more resilient. That's a good word. The difficulty with those
Speaker 1: kinds of things is they're not going to be where
Speaker 1: you expect them. They're gonna they're gonna be in its
Speaker 1: own fash crash type of thing. That's really the wrong
Speaker 1: phrase for it. But you had some really surprising movement
Speaker 1: in bonds, not where people expected to see that. What
Speaker 1: I've always thought is that there'll be people like you
Speaker 1: used to trade in the nineties that will put some
Speaker 1: bids in below the market because they do want to
Speaker 1: own it and at a better price, they'll be happy
Speaker 1: even in the bond market. And so one of the
Speaker 1: issues at the moment is we have what some of
Speaker 1: the academics called knife point liquidity. So everyone's around the
Speaker 1: market a tick or two away because they understand that's
Speaker 1: where the market is now, and that's where the supply
Speaker 1: and demand are. But if the market moves handle for
Speaker 1: a point, if it doesn't kind of gradually, that's okay
Speaker 1: because they can all adjust along the way. But if
Speaker 1: it happens quickly, they assume that there's some news out
Speaker 1: that they don't understand or the model doesn't understand, so
Speaker 1: they back away, and that creates the vacuum. It is
Speaker 1: going to make sense to some people to say, you
Speaker 1: know what, I'm gonna bid down a half a dollar,
Speaker 1: down a dollar, down a dollar and a half, and
Speaker 1: down two dollars, the way the book used to be
Speaker 1: much more like, and stay out there until you know
Speaker 1: they get what they need. If I get filled on
Speaker 1: buying at a discount, what or if I sell it
Speaker 1: on the way up, I'm selling it at a premium.
Speaker 1: And there's all kinds of things you can do with that. So, yes,
Speaker 1: we do have I still believe the structure. The structural
Speaker 1: issue is we have to chase the liquidity rather than
Speaker 1: making it come to the order. And that's where PDQ
Speaker 1: is dramatically different. And it's hard for me to emphasize
Speaker 1: the paradigm shift. So I've got the order. I'm holding
Speaker 1: it here. You can't see it on the radio, but
Speaker 1: I've got into my hand. I want of trade ten
Speaker 1: thousand Apple. I'll tell you the size. What's your market?
Speaker 1: You still don't know whether I'm a buyer or seller.
Speaker 1: Give me your market. All the participants commit to the auction,
Speaker 1: so they can't run away, they can't front run, they
Speaker 1: can't spoof because they don't know what it is. They
Speaker 1: can't penny. They're competing with each other, so their price
Speaker 1: may be a penny better than somebody else. They want
Speaker 1: to give their best price, but they're giving you best
Speaker 1: bid and best gass simultaneously, and it's up to you
Speaker 1: to to to run the auction and find the best
Speaker 1: price for our clients. So that is a big shift
Speaker 1: from what we typically see when someone goes to execute
Speaker 1: an order out in the normal. Back back when I
Speaker 1: was on a level three and you'd see all the
Speaker 1: market makers on each side, you saw a few cents up.
Speaker 1: You had no idea what the real size was, and
Speaker 1: if you were trading any sort of size, you would
Speaker 1: make a rough estimate. Hey, this is gonna cost me
Speaker 1: ten cents to here's two thousand, there's three thousand, there's
Speaker 1: four thousand, there's five thousand. That's how I'll get ten
Speaker 1: or fifteen thousd and filled within a dime or so
Speaker 1: of the actual current bit aness price. You guys have
Speaker 1: turned that on its head. So we make that flow
Speaker 1: come to you. If you're a natural buyer or seller,
Speaker 1: the question is where is the market. We gather the
Speaker 1: responses and it's committed flow to you, and they have
Speaker 1: to commit first, so it's not like they get a
Speaker 1: chance to peak and then run around. So let me
Speaker 1: phrase it as slightly different fascinating. That's a fascinating business model.
Speaker 1: Is there anybody who's a competitor to you for that? Not?
Speaker 1: At the moment um? How much of that is patented trademark?
Speaker 1: We have some IP protection and some patent protection some
Speaker 1: of the venues. So Chicago Stock Exchange has introduced the
Speaker 1: snap auction New York Stock Exchanges talking about a midday
Speaker 1: auction for lightly traded stocks. The London Stock Exchange is
Speaker 1: also now I believe, executing a midday auction, meaning why
Speaker 1: mid day because they just had to pick a time.
Speaker 1: Are doing it once a day. It's not an on
Speaker 1: demand or continuously. You're on demands. Effectively, you send us
Speaker 1: in order, we will create the auction for you whenever
Speaker 1: you want. So that stocks does that include futures. We're
Speaker 1: just stocks at this point, so there's technical reasons why,
Speaker 1: but yes, it's almost on the future that you're going
Speaker 1: to do bonds, futures or any other trade. So structurally,
Speaker 1: the other markets UM have some issues that they don't
Speaker 1: have the A T S functionality meaning to A T
Speaker 1: S for people who automated trading system created by the
Speaker 1: Commission SEC in I believe to promote innovative and alternative
Speaker 1: ways of trading. So we act like a stock exchange
Speaker 1: in terms of matching buyers and sellers, but we're only
Speaker 1: a broker dealer and we're technically regulated by FINRA. The
Speaker 1: exchanges are directly related and regulated to the SEC. And
Speaker 1: this was reg I'm doing this from Emory reg NMS.
Speaker 1: This was reg A t US. It was called um
Speaker 1: Reagan MS was two thousand and five, and that was
Speaker 1: a different market structure plan which actually was incredibly effective
Speaker 1: achieving the goals that had set out to achieve, which
Speaker 1: were well to make the exchanges and orders compete with
Speaker 1: each other. UH and automate the marketplace. I was going
Speaker 1: to say, some people have said Reagan MS is what
Speaker 1: we're high frequency trading really exploded out of the box.
Speaker 1: It turns out it was very beneficial for high frequency trading.
Speaker 1: Little inside story. Back in the get Go days, I
Speaker 1: was there during that period, we were actually concerned that
Speaker 1: that Reagan MS was going to hurt our business because
Speaker 1: you were going to get more competition. There would be
Speaker 1: more competition, and the price protection and other issues would
Speaker 1: make it more difficult for us to function. We had
Speaker 1: no idea. It was going to be a softball all
Speaker 1: down the middle of the right and everybody feasted. So
Speaker 1: it looks like because that was really the wild West
Speaker 1: for a while, and lots and lots. Look at Citadel,
Speaker 1: which started how does the hedge funds is now one
Speaker 1: of the larger, if not largest, liquidity providers. So how
Speaker 1: does a shop that starts out as Ken Griffith Citadel
Speaker 1: in Chicago starts out as essentially a hedge funds? How
Speaker 1: does an enterprise like that suddenly become this giant h
Speaker 1: f T algorithmic trading shop. So one of the changes
Speaker 1: that we made at get Go was to understand that
Speaker 1: we were really a technology shop, not that happened to
Speaker 1: be in the trading space, So we shifted our emphasis
Speaker 1: dramatically to our technology people. Fortunately, all the traders that
Speaker 1: were running the models understood how important the technology was.
Speaker 1: And what happened was that the brilliance of the technology
Speaker 1: folk was was able to make UM the systems better
Speaker 1: and faster, and every time you got better and faster,
Speaker 1: you made more money. So where do you this is?
Speaker 1: I just was up at M I T for the
Speaker 1: Sloan Annual Conference last month. The whole audience were I
Speaker 1: would say two thirds were students, and I very It
Speaker 1: was one of the more intense rooms I've been in.
Speaker 1: And my sense is that many of these kids are
Speaker 1: destined for careers at shops like yours. Where do you
Speaker 1: go out and find the talent, the staff? Where do
Speaker 1: you guys recruit? How do you find the wizards to do?
Speaker 1: What what your stuff? Your technology actually does? So we
Speaker 1: started ten years ago and the team that we started
Speaker 1: with is principally still with us UM. So we found
Speaker 1: folks are Cto has done the recruiting. Were very small shop.
Speaker 1: We just grew from twenty to twenty eight people in
Speaker 1: the last year. So our technology staff is about a dozen.
Speaker 1: We're not actively recruiting because we're not in the what
Speaker 1: I might term is suicidal high speed race. We're going
Speaker 1: to let other people do that. We have really good
Speaker 1: technology and we want it to be incredibly robust, but
Speaker 1: the last micro second isn't critical for our process. That's
Speaker 1: fascinating to me because you spent so you began your
Speaker 1: career on the floor, way back, run, eventually find your
Speaker 1: way into h f T and you're there for the
Speaker 1: fat part of that cycle. So you were really a
Speaker 1: witness firsthands. What made you stop and say, you know,
Speaker 1: there might be more money if we step back and
Speaker 1: try and approach us from a different perspective. How did
Speaker 1: you get to that? So the founder of PDQ is
Speaker 1: a fellow named Christopher Keith. He's a brilliant, brilliant mind.
Speaker 1: Five years young. Now. He's the former CTO of the
Speaker 1: New York Stock Exchange. Okay, so he has some understanding
Speaker 1: of how the exchange works. Perhaps he has a bit
Speaker 1: of a clue about how markets function um understatement of
Speaker 1: the year, understatement of the year. Even in two thousand
Speaker 1: and one he applied for a patent for the p
Speaker 1: d Q idea. Really he understood that at some point
Speaker 1: the race for speed cycle would end, that there would be,
Speaker 1: you know, a physical limit of how fast you could
Speaker 1: go speed alight, speed alight. And even when I was
Speaker 1: at get Go and we were doing better and better
Speaker 1: and going faster and faster, in the back of my mind,
Speaker 1: I was thinking, you know, there's gonna be some point
Speaker 1: where speed doesn't win. It turns out that he we
Speaker 1: had a chance to meet him while I was at
Speaker 1: get Go and my partners made a small investment in PDQ.
Speaker 1: Well it's it's doing fine, UM, but we figured at
Speaker 1: the time we were thinking that it might be a
Speaker 1: source for us to get flow, for us to interact
Speaker 1: with UM. We ended up going in different directions once
Speaker 1: I went to PDQ. But the market structure idea has
Speaker 1: actually been around for quite a while, and so some
Speaker 1: of the folks that think they've discovered new things recently,
Speaker 1: it's it's actually they're just discovering things. Everything sold is
Speaker 1: new again. You know, when you describe the time at
Speaker 1: get co where there's a sense that, hey, this has
Speaker 1: to eventually hit a limit. I just had that vision
Speaker 1: of Robert de Val and apocalypse now where he turns
Speaker 1: to Martin Sheen and says, as if it's a bad thing,
Speaker 1: you know, son, someday this war is gonna end, and
Speaker 1: then walks off, and Sheen looks at him like he
Speaker 1: has two heads. But really that's a that's a fascinating
Speaker 1: moment in the midst of the high frequency trading expansion,
Speaker 1: where well, this has to bump up against the natural
Speaker 1: limit and then what comes next that that's really an
Speaker 1: insightful thought to have when everybody's making a lot of
Speaker 1: money and hey, we figured out a new way of trading,
Speaker 1: and well, let's let's see what this ghost. That's the
Speaker 1: way Chris Keith thinks a step of two ahead of everybody,
Speaker 1: miles ahead of the rest of us. And it was
Speaker 1: fun to get to understand, you know, his ideas. And
Speaker 1: of course the process of collecting the market aggregating the book,
Speaker 1: forcing the providers to go first was a novel idea. Um,
Speaker 1: but what happens I believe is that it benefits all
Speaker 1: participants and what it does it certainly sounds like it would.
Speaker 1: So I got excited about it as a provider because
Speaker 1: I knew there was time to refresh the algorithm in
Speaker 1: give my best market under circumstances that were defined over
Speaker 1: a very short period of time, meaning milliseconds or sconds
Speaker 1: so than microseconds, but still faster than the human eye,
Speaker 1: right exactly. And I also knew that there would be
Speaker 1: opportunities where the model could provide substantial liquidity given the
Speaker 1: circumstances at a particular moment. So if you're doing a
Speaker 1: pair's trade, if you're doing a trade of a stock
Speaker 1: or an et F against futures, and you have a
Speaker 1: chance to assess the market, run your model. Instead of
Speaker 1: doing five chairs, you might be able to do five
Speaker 1: at a given moment under prescribed circumstances. It's very interesting
Speaker 1: to understand how specific that is and how important it
Speaker 1: is to be able to respond with size. There may
Speaker 1: be times when you can't make any market where the
Speaker 1: futures markets. It's just that it's there, right Or you
Speaker 1: think you're going to trade Microsoft against Oracle, and Microsoft
Speaker 1: arneys came out and the market's going a little cucko,
Speaker 1: Well we're gonna wait. But as you find the opportunity
Speaker 1: where you can make a better market, and if you
Speaker 1: have multiple participants who are all going to have a
Speaker 1: different flavor of their better market, and you can aggregate
Speaker 1: them together. All of a sudden, you're gonna you're gonna
Speaker 1: start to find a market that will feel like it
Speaker 1: used to feel. So so you're a dark pool, which
Speaker 1: means you're trading pretty continuously. Do you guys trade before
Speaker 1: market hours and after twenty four hours? Four? How do you?
Speaker 1: How do you do that timeline? Our current trading clock
Speaker 1: is four. We also have a routing business for our clients,
Speaker 1: so if we don't fill them during the auction, we're
Speaker 1: happy to send it either through the darker to a
Speaker 1: destination that they're interested in. We will route before and
Speaker 1: after the close, so we can take an order any time,
Speaker 1: but we don't actually execute it before and after the
Speaker 1: close at this point, and you mentioned the New York
Speaker 1: and London are going to do these by appointment on trades.
Speaker 1: We used to make fun of the illoquid stocks. It's
Speaker 1: it's by appointment only. So from nine thirty to four,
Speaker 1: how actively executing are you? What sort of share counting
Speaker 1: are you guys doing massive shares or is it a
Speaker 1: handful of big clients and you're doing a hundred thousand
Speaker 1: year and half. So we have about a hundred broker dealers, subscribers,
Speaker 1: so they're sending us flow during the day substantial, which
Speaker 1: is pretty substantial. Yeah, I know, about anywhere from sixty
Speaker 1: to seventy five are active on a given day are
Speaker 1: routing and executing business combines for a little bit close
Speaker 1: to one and a half percent of the market, So
Speaker 1: we're doing like a hundred fifty million shares a day
Speaker 1: that's combined. The routing actually is the substantial part of
Speaker 1: the business. That's the lion share, although it may not
Speaker 1: be the lion share profitability wise, but it's gonna be
Speaker 1: the lion share volume wise. Yes, So we're thrilled. I mean,
Speaker 1: when we got to one percent about a year ago,
Speaker 1: we thought that was a great milestone, um, but that's
Speaker 1: still relatively small for some of the dark pools out
Speaker 1: there are are huge, right, there's five and ten percent.
Speaker 1: The biggest ones is that is that Well, that might
Speaker 1: be a little high, maybe closer three to six. But
Speaker 1: a couple of other facets about our auction process after
Speaker 1: a trade has made our t c A reports show
Speaker 1: that we have very little impact on the market. So
Speaker 1: you're not moving the price, so we're not moving right.
Speaker 1: Institutions love that I should say, they want to be
Speaker 1: able to get in or out without causing a disruption
Speaker 1: because you never know what they have behind that they
Speaker 1: might have another Hey, I got ten ten million more
Speaker 1: to go, try not to wreck the bid. So familiar
Speaker 1: of course days right, of course. UM. One thing that
Speaker 1: I'm very proud of is when our liquidity providers respond.
Speaker 1: Their average size is shares way above the average trade
Speaker 1: size and in terms of larger trades. For the month
Speaker 1: of February, we received about thirty five thousand trades of
Speaker 1: over five thousand shares from our initiators from the subscribers
Speaker 1: looking for liquidity, and our providers responded, this is our
Speaker 1: daily average with over a hundred and thirty five thousand
Speaker 1: blocks of over five thousand shares. A lot of it
Speaker 1: may not have traded, but it was there and it
Speaker 1: was available. Um. Sometimes the providers are on the same
Speaker 1: side of the market as the order. Sometimes they're appending
Speaker 1: your two away from the market, so they may not
Speaker 1: they may not cross, they may not match, UM, but
Speaker 1: that opportunity is there, and I think that's the important thing.
Speaker 1: So how do you guys get paid? Is it on
Speaker 1: a preshare basis? What do you guys judge for share
Speaker 1: is that is that public info? Um, I'd love to
Speaker 1: make it public information. And the problem is it's custom
Speaker 1: So everybody, depending on what they're doing, the size frequency,
Speaker 1: you're gonna work out some arrangement on some sort of
Speaker 1: grid for them. Even more than that. So once we
Speaker 1: have a conversation with our client, they're not latency sensitive,
Speaker 1: they've agreed after PDQ we can route through the dark
Speaker 1: and end up going through bats. Let's say we can
Speaker 1: actually give them a sliding scale. Because we're in a
Speaker 1: t S we don't have to have one size fits
Speaker 1: all pricing, which in exchange does. So if you if
Speaker 1: we feel you at p d Q, we can give
Speaker 1: you a free fill. If we go into the dark,
Speaker 1: we may have to charge you eight mills. It's costing
Speaker 1: relatively inexpensive. Relatively inexpensive, but it might be costing US
Speaker 1: four or five. We get a little mark up for
Speaker 1: the house because we've got to keep the lights on
Speaker 1: as we go through the dark. The price gradually goes up.
Speaker 1: Eventually we send you to the lip market. Are active
Speaker 1: traders save about of the take fee from the lip
Speaker 1: market by coming to PDQ, And and that's why people
Speaker 1: like Vanguard and Dimensional are not really that critical of
Speaker 1: HFT because to them there's a cost saving. Absolutely that
Speaker 1: that makes a lot of sense. I could stay in
Speaker 1: the weeds all day. I find this stuff fascinating, But
Speaker 1: I know I only have you for another fifteen minutes,
Speaker 1: so let me get to some of my favorite questions
Speaker 1: and uh, well, we'll see where this goes. So you
Speaker 1: mentioned in the early days you started, you were on
Speaker 1: the floor. Was it New York or Chicago? I started
Speaker 1: on the American Stock Exchange and then went to the
Speaker 1: CBO E flour And so what did you do before
Speaker 1: financial services? I jumped into it right out of college.
Speaker 1: When I was in college, I actually had a house
Speaker 1: painting business that I ran with ten other guys that
Speaker 1: were working for me. So that was less late and
Speaker 1: seem more LATEX and that sort of stuff. I got
Speaker 1: it good. Um, So, who are some of your early
Speaker 1: mentors in this industry? Um Ken langn oh? Really, I
Speaker 1: was actually depot Ends It was both medical center and
Speaker 1: in the med Associates is the name of his broke
Speaker 1: in the med e D. I was partners with him
Speaker 1: um in the late seventies and early eighties as a
Speaker 1: floor trader, and he said, I have this idea for
Speaker 1: a home. I was never to offer the opportunity. It
Speaker 1: turns out, I don't know whether I what I would
Speaker 1: have done, but I could dream. You want to sell
Speaker 1: plywood and giant warehouses, Ken, listen, stick to trade by
Speaker 1: the way, you become a multi billionaire, right that? It
Speaker 1: ends up? It's a It's a great American. We should
Speaker 1: have him on the air one of these days. I'd
Speaker 1: love to. He's still in touch with him. No, and
Speaker 1: he's a no nonsense, a little gruff. But was he
Speaker 1: always that way? Is that that's his persona, that's his persona.
Speaker 1: He never he calls a spade a spade, right that?
Speaker 1: That's pretty pretty funny? Any other mentors worth? A trader
Speaker 1: named John Mulhern was legendary back in the day, all right,
Speaker 1: I've heard the name. He was at Merrill Lynch Bar
Speaker 1: Wagner actually partners with is the England Or at one point.
Speaker 1: Um a man who just had a beautiful different perspective
Speaker 1: on the world. Um was a extraordinary natural trader, if
Speaker 1: there is such a thing. Back in the day when um,
Speaker 1: some people just have a feel for what's going on
Speaker 1: and what's about to happen? Um. I also did not
Speaker 1: know him personally, but followed the career Bob Ruben risk
Speaker 1: arb Trage from Goldman Saxon of course Secretary Treasury and
Speaker 1: other things like that. So um, I enjoyed reading about
Speaker 1: people in the business. And um, so let's talk about books.
Speaker 1: What are some of your favorite books? Fiction? Non fiction,
Speaker 1: finance nine finance. So I always get fascinating answers to
Speaker 1: this question. The one that I decided I want to
Speaker 1: tout is called the Rational Optimist. Oh, of course, Matt Ridley,
Speaker 1: and for folks that are struggling with the world in
Speaker 1: which we live and think things are not good. Um.
Speaker 1: His argument is, we've never there's never been a better
Speaker 1: time to be alive. You could look at it many metries, lifespan, healthcare,
Speaker 1: amount of wars, amount of murders, amount of crime. Even
Speaker 1: though these things are on the headlines and we all
Speaker 1: have more access to it. By the numbers, it's actually
Speaker 1: much better than it was even fifty or thirty years ago. Right,
Speaker 1: So um, Warren Buffett says, the normal average person today
Speaker 1: has a much better life than Rockefeller did a hundred
Speaker 1: years ago. I mean, I would agree with that completely
Speaker 1: relative to someone a hundred years ago. Sure, but at
Speaker 1: the time Rockefeller was he King of the health. It's
Speaker 1: always it's always uh hey, listen, Louis the sixteenth didn't
Speaker 1: have into a plumbing but four hundred servants to make
Speaker 1: his dinner. Right, That's that's exactly right. Um, so the
Speaker 1: Rational Optimist, any other books you you feel like mentioning
Speaker 1: trying to think of others that. I mean, some of
Speaker 1: the market structure ideas and so forth. Those types of
Speaker 1: things tend to wander up and down. I mean, some
Speaker 1: of them are great, some of them are terrible. Um,
Speaker 1: so you kind of have to be a little selective there.
Speaker 1: I'm involved. My wife and I have created a little
Speaker 1: foundation called the Raven Foundation. It's an education foundation that
Speaker 1: has a whole um anthropology behind it, if you will.
Speaker 1: Some of my reading is focused in that direction. Um.
Speaker 1: I remember reading the biography of Peter the Great, really fascinating. UM.
Speaker 1: Biography comes up all the time when the show people constantly.
Speaker 1: I can't tell you begin to tell you how many
Speaker 1: people have mentioned and um, the right Brothers body that
Speaker 1: just came in, right, I haven't got that. I know
Speaker 1: a lot of people have have that on the kindle
Speaker 1: waiting waiting to go. Um. So we've discussed all the
Speaker 1: different things that's changed over the past thirty years. Rather
Speaker 1: than reiterate that, what do you see shifting over the
Speaker 1: next decade in terms of anything involving markets and execution?
Speaker 1: What is the next wave of change gonna Well, I
Speaker 1: believe PDQ was part of that in terms of our
Speaker 1: process of aggregating the market and creating an auction right. Um, So,
Speaker 1: innovative trading structures are going to shift the way people
Speaker 1: get Excertainly that's our hope a PQ. Um. It certainly
Speaker 1: makes you should be you should be the CEO of
Speaker 1: the company. Becush, you are hounding the table on it.
Speaker 1: But not just your firm, I mean, but you guys
Speaker 1: have to anticipate where the market's going to go and
Speaker 1: how execution is going to change. What else do you
Speaker 1: see without revealing any of these So the where do
Speaker 1: you see this shifting in the future? The markets are
Speaker 1: still even though we think we're global, we're always becoming
Speaker 1: more global and so you know, China sneezes and we
Speaker 1: catch a cold. Those types of intricacies are going to
Speaker 1: continue to evolve. Do you guys have plans to expand overseas.
Speaker 1: Yet certainly London is an option, and then Hong Kong.
Speaker 1: London and Hong Kong are obvious options. It turns out
Speaker 1: that our market structure for an independent, non government firm
Speaker 1: to get started in a foreign country challenging, is very challenging.
Speaker 1: And so the beauty of Reggaets was a couple of
Speaker 1: guys with an idea could try to spin up a
Speaker 1: better matching process and if it hunts, we can make
Speaker 1: a living, hopefully make the market a better place. It's very,
Speaker 1: very difficult. In other countries. Most of the exchanges are
Speaker 1: run by the government. Is that true? So is it
Speaker 1: l and independent? And I believe the LSC is independent.
Speaker 1: So you you caught me on that one already. But
Speaker 1: I know China and Hong Kong are just totally different animals,
Speaker 1: although you would think Hong Kong would be the closest
Speaker 1: thing to a non government entity that China. I happened
Speaker 1: to be at a conference there a couple of summers
Speaker 1: ago and gave a little presentation on market structure, and
Speaker 1: the big buzzword then was kill switches. And it was
Speaker 1: fascinating to me because they had a person from the
Speaker 1: Hong Kong Exchange talking about it, and he says, kill switch.
Speaker 1: Are you kidding me? Who knows what the person that
Speaker 1: I'm turning off? What resources they have, what are the
Speaker 1: trades they have, what position they have. We're in exchange,
Speaker 1: We're not the broker dealer. We don't have the understanding
Speaker 1: of their financial wherewithal we may be forcing them to
Speaker 1: take incredible losses with a kill switch. They were terrified
Speaker 1: of kill switches. Over here we're talking about everyone should
Speaker 1: have a kill switch and be able to flip at
Speaker 1: any time. You've got to be really careful with these things,
Speaker 1: be because the unintended consequences can really be an issue.
Speaker 1: That that's that's quite fascinating. Um my favorite two questions
Speaker 1: in the last few minutes we have. So a recent
Speaker 1: college grad, a millennial comes to you and says, I'm
Speaker 1: thinking about going into finance. I'm interested in trading. What
Speaker 1: sort of advice would you give them? So back to
Speaker 1: your question about why I got involved, I thought it
Speaker 1: was going to be an easy way to make a living, right,
Speaker 1: so fully understand that whatever you earn you're gonna have
Speaker 1: to work very hard for even though it appears that
Speaker 1: you can show up and be Mr Citadel and trade
Speaker 1: from your dorm and create billions of dollars. How many
Speaker 1: people get to be It's a very rare event, Kevin Griffin.
Speaker 1: I mean, you're talking you. It's funny because people talk
Speaker 1: about Jim Simmons, or they'll talk about um uh Stevie Cohen.
Speaker 1: These are real outliers. These are one in a hundred
Speaker 1: million personalities. These aren't like, hey, let's all become traitors
Speaker 1: and become billionaires like Curry or Michael Jordan's. The odds
Speaker 1: are so overwhelmingly stacked against you that unless you are
Speaker 1: unusually gifted. I did an analysis on this exact subject
Speaker 1: some years ago, looking at how many kids were high
Speaker 1: school athletes millions, and then how many of those high
Speaker 1: school athletes become college athletes, which is a single digit percentage,
Speaker 1: And then how many of those college athletes actually get
Speaker 1: to enter the draft again a tiny, tiny percentage. And
Speaker 1: those people who go on to be in the draft,
Speaker 1: how many of them actually have a career. Forget Stephen
Speaker 1: Curry and Michael Jordan's earn a living as a professional athlete.
Speaker 1: So when you go back to that original pool of
Speaker 1: high school athletes. It's such an infinitessimal number, and it's
Speaker 1: turns out on the trading side, it's even smaller. The
Speaker 1: Jim Simons and Steve Cohens and Kevin Griffiths are like
Speaker 1: rarer than the Stephen Carries and Michael Jordan's. It's it's amazing,
Speaker 1: agree and so so the advice to a millennial would
Speaker 1: be what, Well, hopefully you're smart, Hopefully you're willing to
Speaker 1: work hard. There will always be capital transactions, there will
Speaker 1: always be mergers and acquisitions and corporations that need advice
Speaker 1: around financing and currency exposure and interest rate exposure. Find
Speaker 1: an area that you really love, understand it as well
Speaker 1: as you can. Probably spend some time with someone who's
Speaker 1: doing what you think you might want to do. So
Speaker 1: have an apprenticeship if you will, get into a training program,
Speaker 1: get a taste for it, and then decide if it's
Speaker 1: really for you, or if maybe you want to go
Speaker 1: back to business school and look at industry or something else,
Speaker 1: other other options. I tried to my son happens to
Speaker 1: be in the business, actually tried to talk him out
Speaker 1: of it. He wouldn't listen. Um Anyway, it's worked out
Speaker 1: for him, but it uh, it is very captivating and
Speaker 1: seductive to see the opportunity. And when you had those
Speaker 1: days where you caught a trade and you make two
Speaker 1: d fifty dollars without a lot of effort, you know
Speaker 1: that was a week of painting houses when I was
Speaker 1: that's exactly right, right, that's exactly when I sit there
Speaker 1: and go see which would I rather do. There's something
Speaker 1: about working with your hands that's satisfying, although I I
Speaker 1: prefer working in the garden once a week then painting house.
Speaker 1: My last question, and one of my favorites. What is
Speaker 1: it that you know about investing, about trading, about market
Speaker 1: structure that you wish you knew forty years ago when
Speaker 1: you were setting out on this career. So when I
Speaker 1: was studying in the markets, um I actually had Burton
Speaker 1: Malkiel efficient market theory random Walk Down, Random Walk Down
Speaker 1: Wall Street that had been published just a year or
Speaker 1: two before I took his course. UM I was a
Speaker 1: big believer of that coming out of school. Looking at
Speaker 1: thirty or forty years of the markets, I think he's
Speaker 1: right there. Efficient around the edges, they're efficient because you
Speaker 1: can't necessarily pick the ones that are going to win
Speaker 1: and lose, but well, the might the markets are also
Speaker 1: psychologically driven. Witness the Internet bubble, which I lived through,
Speaker 1: traded through. It was fascinating to me at one point
Speaker 1: and a ninety nine early two thousand. Some of the
Speaker 1: most brilliant minds, we're totally confused. So the biggest hedge
Speaker 1: fund guys. One was a chronic short, one was a
Speaker 1: chronic long. Neither one of them knew what to do
Speaker 1: with their portfolio because prices were in this new dimension. Well,
Speaker 1: it turned out there wasn't a new dimension. It was
Speaker 1: just that we thought there might be. So there are
Speaker 1: dislocations in the market. There will be times when having
Speaker 1: a level head gives you an opportunity, and the only
Speaker 1: way to really participate well with that is to not
Speaker 1: be levered. So it's leverage that has killed us, both
Speaker 1: in the recent crisis and in the past crises. Don't
Speaker 1: over extend yourself thinking that you've got the answer to
Speaker 1: where the market's gonna go or what's going to happen.
Speaker 1: Uh again, Warren Buffett tells a great story. If you
Speaker 1: had invested ten thousand dollars with him, and sixty seven
Speaker 1: would be worth whatever it is, tens of millions today
Speaker 1: if you had invested twenty dollars and borrowed ten, so
Speaker 1: if you did it on margin, you would have been
Speaker 1: out of business. Sometimes options and futures and all that
Speaker 1: kind of stuff. I like to say it's for people
Speaker 1: who want to get there in a hurry, but they
Speaker 1: may not know where they're going right, so it could
Speaker 1: work out, but it also could build a lot of characters.
Speaker 1: The way I used to talk about my losing trades.
Speaker 1: The Buffett quote I remember, and I'm sure i'm mangling
Speaker 1: this about leverage was, you know, dumb people should never
Speaker 1: use leverage, and smart people don't need to use leverage,
Speaker 1: so that that works that well. Keith, this has been
Speaker 1: absolutely fascinating. I appreciate you spending um so much time
Speaker 1: with us on this. We have been speaking with Keith Ross.
Speaker 1: He is the CEO and chairman of PDQ Enterprises. If
Speaker 1: you enjoy this conversation, be sure and look up an
Speaker 1: inch or down an inch on Apple iTunes. You can
Speaker 1: see the other ninety or so of these uh conversations
Speaker 1: we've had. I would be remiss if I did not
Speaker 1: thank Taylor Riggs, who was in charge of producing and
Speaker 1: booking our show. Charlie Vomer is our producer, Colin my engineer.
Speaker 1: Michael Batnick is the head of our research who helps
Speaker 1: put these questions together. You've been listening to Masters in
Speaker 1: Business on Bloomberg, a radioh