What is a D-Limit Order?

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A Discretionary Limit Order or D-Limit Order uses artificial intelligence to protect traders from latency arbitrage trading strategies.

The innovative order type was created by the IEX group and achieved SEC approval in August of 2020.

What is Latency Arbitrage?

Market makers will essentially intercept or “pick off” retail trader’s orders and profit from a difference in spread. 

For example, say that a sell order for stock $XYZ is placed at $10.50. Then at a different exchange, a buy order for the same stock is set at $10.55.

By using lightning-fast high-frequency trading programs, the market maker will buy the order at $10.50 and sell it at $10.55. This makes for a quick and relatively risk-free profit. 

Latency arbitrage is detrimental to both liquidity and retail traders. It’s estimated to cost investors nearly $5 billion per year across global exchanges.

IEX wants to level the playing field with the D-Limit Order. 

What is the Investors Exchange (IEX)?

The Investors Exchange, identified as IEX, started as a private US-based stock exchange. Once it attained some popularity, it became a public stock exchange in 2016. 

IEX was created in response to the shady practices commonly used at other Wall Street exchanges. 

It promises investors that it operates in only honest and transparent practices. IEX refuses to pay for order flow and promotes a fair trading environment. 

How Does the D-Limit Order Work?

The D-Limit Order uses an empirical model created by IEX called the Crumbling Quote Indicator (CQI).

The CQI estimates when prices are going to change then adjusts the limit price. This protects against unfavorable price changes and stops high-frequency traders from picking off limit orders. 

Ultimately, a D-Limit Order uses exchange-created AI to match the AI used by latency arbitrage traders.

The order type works only for “lit” trading. (Lit means visible trades that are non dark-pool.)

IEX states CQI is “on” less than 1% of the trading day, and 24% of trades happen while it is “on.”

Pros

A D-Limit Order keeps retail traders from becoming prey to the more sophisticated HFT market makers.

IEX uses its speedy hi-tech resources to benefit all limit order traders. 

Cons

The order type is still very new in the trading world. It is yet to be seen how well it works across different market types and during periods of high volatility. 

You will need to route your trades to IEX. Sadly, it is not available on most brokerages.

The trouble to use IEX may not be worth it. In reality, HFT typically has a low impact on most retail traders. 

Why is Citadel Securities Against it?

The leading global market maker Citadel Securities is suing the SEC over the approval of the D-Limit Order.

The company believes the order type will damage the integrity of the US stock market.

A spokeswoman from Citadel Securities said in an email that it would “harm retail investors.” Yeah right. That is the exact opposite intention of the D-Limit order.

It’s obvious why Citadel Securities is against the new order type. It will hurt their bottom line. How? By lowering profits from their predatory trading strategies. 

Final Thoughts

The D-Limit Order is an interesting and futuristic order type. And its arrival seems to be stirring things up on Wall Street. 

Latency arbitrage and high-frequency trading can upset a lot of traders. How badly it really affects your trades is debatable. 

Overall, the D-Limit order is a step in the right direction. Who knows? It may just lead to better trading practices. Practices that will benefit retail investors.