[harryh]

1) No one would submit any bids until the last possible millisecond before the auction closed so that they could gather as much information as possible to inform their bid.

2) Bid/ask spreads would increase dramatically because market makers would be taking on far more risk of dramatic price changes in between auctions. This would dramatically increase costs to you, the investor.

[logfromblammo]

Sealed bid. No information is available except the volume and price from clearing the LAST auction.

I'm not aware of any reason why market makers would be required in such a system. Market makers are used in continuous trades such that price information can be continuously reported. There is no such need here.

Your objections seem to indicate that I did not explain my proposal such that you could easily understand my intent.

[kasey_junk]

Ok, with the extra comments I now understand your proposal is much more radical than I originally thought. You are suggesting a completely obscured order book. I don't know of any markets that operate that way so I don't have any proof about how well price discovery would work in that system. My instinct is that most participants would become very nervous about setting their prices and therefore the spreads would be very wide, and not much trading would occur.

That said, your system still doesn't address the priority issue. Lets say in your new bid system we got lucky and a lot of people without knowledge of the order book picked the same price for both buying and selling an instrument. But there were more people on the buy side than the sell side (or vice versa). Who gets filled and who doesn't?

[logfromblammo]

If there were more numbers on the buyer side, all buyers exactly at the clearing price would have an equal fraction of their order filled.

If buyers at $10 or lower want 300, 100, and 10, and sellers at $10 or higher have 205, and the clearing price is $10, then each buyer at $10 or lower gets 50% of what he wanted.

Everyone who bid higher buys everything they wanted. Everyone who bid lower buys nothing.

Simply put, the algorithm to find the clearing price is similar to drawing supply and demand in your high school micro-economics class. The bids are put in order, highest price to lowest, forming the demand curve. The offers are put in order, lowest to highest, forming the supply curve.

At the point where they cross, if they cross, is the price and quantity that gets traded. The system knows, but does not publicly reveal, the amounts that the buyers and sellers who actually traded in this auction would have still traded at.

In continuous trades, the difference does NOT go to the buyer or seller. It usually goes to a professional middleman. Therefore, the current system is optimized to capture as much of this benefit as possible for the middleman. But it still leaves tiny sawtooth areas close to the curve that cannot be captured unless you can trade on infinitesimal time slices for arbitrarily precise fractions of a dollar.

Clearing multiple trades at once means that the arbitrageur can only capture value from the marginal buyers and sellers, if anyone, and everyone else can actually enjoy the benefit of trade. The amount taken by the exchange is one trangular area, rather than multiple rectangles, thus has no deadweight loss.

[kasey_junk]

I don't know of any systems that implement equal % matching algorithms but I'd expect it would encourage games where you just send in more smaller orders (hiding their relation to each other if you are particularly shady) so that you would improve your fill rates.

Your hidden book time auction idea is not one I've seen implemented. Again I think it would be very detrimental for price discovery but can't prove that.

Just trying to think of it as a market participant, how do I determine what price I should bid or offer?

I can also think of all kinds of ways for this system to be gamed. The first thing I would try if I were making markets in this system is to ladder small quantity orders right around the last trade price. Then when you get filled on these orders they would act as high/low water marks letting you zero in on the correct price.

Not sure why I would want to encourage this sort of gaming instead of an open book, but I'd certainly like to try it if you ever create your exchange.

[Edit] re-read original comment and realize it is not pro-rata matching.

[harryh]

1) Sealing the bids certainly contains some information but what about, you know, the real world. Lots of things are continuing to happen in the real world that effect the value of securities. I want to incorporate as much of that information as possible into my bid so I'm gonna wait until the last possible moment to submit my bid.

2) Bid/ask spreads would increase for regular people not just market makers. If you increase the restrictions under which something can be traded that ads risk to making a trade. That will push apart spreads. The existence of market makers is orthogonal to that principal.

[logfromblammo]

Large bid/ask spreads benefit buyers and sellers if they are allowed to keep the benefit of trade trade for themselves.

If I would pay $10 to buy, and a seller would accept $8 to sell, and the clearing price is $9, we each benefit.

If The seller sells at $8.01 to a middleman, who sells at $9.99 to me, only the middleman benefits. He has captured almost the entire benefit of trade from us.

Spreads do not matter here. The buyer and seller agree to trust a third party cartel enforcer to keep their trade information secret for the express purpose of excluding arbitrageurs. They do this because they can then get higher prices for what they sell, and lower prices for what they buy.

If the earnings report is scheduled to be released in the middle of an auction interval, yes, you might want to wait before using the system. But you might not care. Your numbers might be based upon research rather than speculation. This system is designed to be more friendly to the people who trade based on what the goods at hand are worth to them, rather than how much money they can make speculating on movements in the price. That's the whole point.

Your objections seem to be that the people who make a lot of money in the current system can't do that as easily here. Again, that's the point. As I see it, the people making the most money are providing the least value, while also trying to pretend that no one could live without them.

What if they could all be replaced by a very short shell script?

[harryh]

> If I would pay $10 to buy, and a seller would accept $8 to sell, and the clearing price is $9, we each benefit.

That's not how bid/ask spreads work. You have it backwards. A big spread is when the highest anyone willing to pay is $8 and the lowest anyone is willing to sell for is $10.

Large bid/ask spreads hurt both buyers and sellers because as soon as they make a trade they are already in a hole (that they hope to make up by overall movement in the security).

[logfromblammo]

That trade is not going to happen, man. That's another way of saying that everybody is already perfectly happy without trading at all.

If trade volume is zero, the auction reports the price as whatever the most desperate seller would accept. Anyone who wants to actually buy in the next interval should probably offer more than the value reported in the previous interval.

But since the trade orders are secret, you don't actually know how big the spread is. You only know how much traded at the last price. Again, you are very intently focused on something that has very little relevance to the proposed system.

You have no way of knowing what the spread is. That is intentionally hidden via a cartel arrangement to exclude arbitrageurs. No one trades unless everyone is happy with the trade. If no trades occur, everyone was already happy enough with what they have. That is not a problem that needs fixing.

[harryh]

OK, let me make a real world comparison. Imagine the market for collectibles in the pre eBay world. The market was much less efficient. It was much harder to match buyers with sellers. If you had a Ken Griffey baseball card to sell you probably couldn't get a great price because matching up with a buyer was harder. At the same time if you wanted to buy one you probably had to pay a higher price because you had to go to a special baseball card dealer. Spreads between what you could sell for and what you had to pay to buy were very large.

Then eBay comes along and the market is way more efficient. You can buy and sell with anyone in the world and it's (relatively) fast and easy! Bids go up, asks go down and spreads decrease! It's a win for everyone other than the middle men (baseball care dealers).

The faster and easier it is to trade, the smaller spreads are, the better pricing is, the less middle men make.

Your proposal would move the system back in the other direction because you're making trading slower & harding and impeding information flow between everyone. There is no market in which secrecy or slowness benefits the actual customer and not the middle men.