High Frequency Trading (HFT)
The study of HFT is a study of market parasitism. The
following introduction was adapted from blong post
Risk and Reward in High Frequency Trading.
paper on the profitability of high frequency traders provided some insights about the nature of this
parasitism. The key mechanism is that they put themselves into position of
"forced intermediaries" -- other market participants are forced to sell stock to
them and then they sell it back getting a tiny profit from most traction. If
they "misunderestimate" the direction of the market they sell position with loss
and do it quickly minimizing overnight exposure to a bare minimum.
So they are the same type of intermediaries as theater tickets scalpers.
By definitions high frequency traders are characterized by three metrics:
- a very large volume,
- a very short (usually less the intraday) holding
- a very limited overnight and intraday directional exposure
From the paper:
For each day there are three categories a potential trader must satisfy to be
considered a HFT: (1) Trade more than 10,000 contracts; (2) have an end-of-day
inventory position of no more than 2% of the total contracts the firm traded
that day; (3) have a maximum variation in inventory scaled by total contracts
traded of less than 15%. A firm must meet all three criteria on a given day
to be considered engaging in HFT for that day. Furthermore, to be labeled an
HFT firm for the purposes of this study, a firm must be labeled as engaging
in HFT activity in at least 50% of the days it trades and must trade at least
50% of possible trading days.
Of more than 30,000 accounts studied in the paper, only 31 fit this description.
But these firms dominate the market, accounting for 47% of total trading volume
and appearing on one or both sides of almost 75% of traded contracts. And they do
this with minimal directional exposure: average intraday inventory amounts to just
2% of trading volume, and the overnight inventory of the median HFT firm is precisely
This small set of firms is then further subdivided into categories based on the
extent to which they are providers of liquidity. For any given trade, the liquidity
taker is the firm that initiates the transaction, by submitting an order that is
marketable against one that is resting in the order book. The counterparty to the
trade (who previously submitted the resting limit order) is the liquidity provider.
Based on this criterion, the authors partition the set of high frequency traders
into three subcategories: aggressive, mixed, and passive:
To be considered an Aggressive HFT, a firm must... initiate at least 40% of
the trades it enters into, and must do so for at least 50% of the trading days
in which it is active. To be considered a Passive HFT a firm must initiate fewer
than 20% of the trades it enters into, and must do so for at least 50% of the
trading days during which it is active. Those HFTs that meet neither... definition
are labeled as Mixed HFTs. There are 10 Aggressive, 11 Mixed, and 10 Passive
This heterogeneity among high frequency traders conflicts with the common claim
that such firms are generally net providers of liquidity. In fact, the authors find
that "some HFTs are almost 100% liquidity takers, and these firms trade the most
and are the most profitable."
The authors are able to compute profitability,
risk-exposure, and measures of risk-adjusted performance for all firms. The average HFT makes over $46,000 a day; aggressive firms make more than
twice this amount. The standard deviation of profits is five times the mean, and
the authors find that "there are a number of trader-days in which they lose money...
several HFTs even lose over a million dollars in a single day."Despite the volatility in daily profits, the risk-adjusted performance of high frequency
traders is found to be spectacular:
HFTs earn above-average gross rates of return for the amount of risk they take.
This is true overall and for each type... Overall, the average annualized Sharpe
ratio for an HFT is 9.2. Among the subcategories, Aggressive HFTs (8.46) exhibit
the lowest risk-return tradeoff, while Passive HFTs do slightly better (8.56)
and Mixed HFTs achieve the best performance (10.46)... The distribution is wide,
with an inter-quartile range of 2.23 to 13.89 for all HFTs. Nonetheless, even
the low end of HFT risk-adjusted performance is seven times higher than the
Sharpe ratio of the S&P 500 (0.31).
These are interesting findings, but there is a serious problem with this interpretation
of risk-adjusted performance. The authors are observing only a partial portfolio
for each firm, and cannot therefore determine the firm's overall risk exposure.
It is extremely likely that these firms are trading simultaneously in many markets,
in which case their exposure to risk in one market may be amplified or offset by
their exposures elsewhere. The Sharpe ratio is meaningful only when applied to a
firm's entire portfolio, not to any of its individual components. For instance,
it is possible to construct a low risk portfolio with a high Sharpe ratio that is
composed of several high risk components, each of which has a low Sharpe ratio.
To take an extreme example, if aggressive firms are attempting to exploit arbitrage
opportunities between the futures price and the spot price of a fund that tracks
the index, then the authors would have significantly overestimated the firm's risk
exposure by looking only at its position in the futures market. Over short intervals,
such a strategy would result in losses in one market, offset and exceeded by gains
in another. Within each market the firm would appear to have significant risk exposure,
even while its aggregate exposure was minimal. Over longer periods, net gains will
be more evenly distributed across markets, so the profitability of the strategy
can be revealed by looking at just one market. But doing so would provide a very
misleading picture of the firms risk exposure, since day-to-day variations in profitability
within a single market can be substantial.
The problem is compounded by the fact that there are likely to by systematic differences
across firms in the degree to which they are trading in other markets. I suspect
that the most aggressive firms are in fact trading across multiple markets in a
manner that lowers rather than amplifies their exposure in the market under study.
Under such circumstances, the claim that aggressive firms "exhibit the lowest risk-return
tradeoff" is without firm foundation.
Despite these problems of interpretation, the paper is extremely valuable because
it provides a framework for thinking about the aggregate costs and benefits of high
frequency trading. Since contracts in this market are in zero net supply, any profits
accruing to one set of traders must come at the expense of others:
From whom do these profits come? In addition to HFTs, we divide the remaining
universe of traders in the E-mini market into four categories of traders: Fundamental
traders (likely institutional), Non-HFT Market Makers, Small traders (likely
retail), and Opportunistic traders... HFTs earn most of their profits from Opportunistic
traders, but also earn profits from Fundamental traders, Small traders, and
Non-HFT Market Makers. Small traders in particular
suffer the highest loss to HFTs on a per contract basis.
Within the class of high frequency traders is another hierarchy: mixed firms lose
to aggressive ones, and passive firms lose to both of the other types.
costs incurred by such firms include payments for data feeds, computer systems,
co-located servers, exchange fees, and highly specialized personnel. Most of these
costs do not scale up in proportion to trading volume. Since the least active firms
must have positive net profitability in order to survive, the net returns of the
most aggressive traders must therefore be substantial.
In thinking about the aggregate costs and benefits of all this activity, it's
worth bringing to mind
It is the iron law of the markets, the undefiable
rules of arithmetic: Gross return in the market, less the costs of financial
intermediation, equals the net return actually delivered to market participants.
The costs to other market participants of high frequency trading correspond roughly
to the gross profitability of this small set of firms. What about the benefits?
The two most commonly cited are price discovery and liquidity provision. It appears
that the net effect on liquidity of the most aggressive traders is negative even
under routine market conditions. Furthermore, even normally passive firms can become
liquidity takers under
stressed conditions when liquidity is most needed but in vanishing supply.
As far as price discovery is concerned, high frequency trading is based on a strategy
information extraction from market data. This can speed up the response to changes
in fundamental information, and maintain price consistency across related assets.
But the heavy lifting as far as price discovery is concerned is done by those who
feed information to the market about the earnings potential of publicly traded companies.
This kind of research cannot (yet) be done algorithmically.
A great deal of trading activity in financial markets
is privately profitable but wasteful in the aggregate, since it involves
a shuffling of net returns with no discernible effect on production or economic
growth. Jack Hirschleifer made this
point way back in 1971,
when the financial sector was a fraction of its current size. James Tobin
reiterated these concerns a decade or so later. David Glasner, who was fortunate
enough to have studied with Hirshlefier, has recently described our predicament
Our current overblown financial sector is largely built on people hunting, scrounging,
doing whatever they possibly can, to obtain any scrap of useful information
— useful, that is for anticipating a price movement that can be traded on. But
the net value to society from all the resources expended on that feverish, obsessive,
compulsive, all-consuming search for information is close to zero (not exactly
zero, but close to zero), because the gains from obtaining slightly better information
are mainly obtained at some other trader’s expense. There is a net gain to society
from faster adjustment of prices to their equilibrium levels, and there is a
gain from the increased market liquidity resulting from increased trading generated
by the acquisition of new information. But those gains are second-order compared
to gains that merely reflect someone else’s losses. That’s why there is clearly
overinvestment — perhaps massive overinvestment — in the mad quest for information.
To this I would add the following: too great a proliferation of information extracting
strategies is not only wasteful in the aggregate, it can also result in
market instability. Any change in incentives that substantially lengthens holding
periods and shifts the composition of trading strategies towards those that transmit
rather than extract information could therefore be both stabilizing and growth enhancing.
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A strange game. The only winning move is to not play.
~ The W.O.P.R. computer on "Wargames"
Since Cro-Magnon Man began trading flint, furs, and women,
there have been nefarious activities in the marketplace.
Painting the tape-moving markets at the end of a quarter to dupe
customers-is tolerated. The pop icon Jim Cramer spilled his guts
describing how players of even modest means can push prices
I bet Jim would like a do-over on that video. Options expiration
week is always exciting, as the options dealers purportedly move
the equities to minimize payouts on the heavily leveraged
options to maximize pain on the plebeians. Insider trading is a
death sentence for a nobody, but is a misdemeanor for the big
bankers. When caught, the going rate on the punishment of
investment banks is a 3-5% surcharge on the profit from the
illicit trade. One can only imagine how much it would cost us in
punitive rebates if the criminal behavior caused a loss.
In general, however, blaming markets for your losses is a
fool's game. Nonetheless, something has changed. The Federal
Reserve-the Fed-has explicitly stated a vested interest in both
the magnitude and direction that markets move, abandoning all
willingness to let markets determine prices. These guys are
playing God, taking full possession of our hopes and dreams. In
analogy to global warming, their loose monetary policy jacks up
prices with markedly increased volatility and enormous social
costs. Kevin Phillips' 2005 American Theocracy is a
brilliant account of the demise of Western empires. He notes
that the final death rattle is the financialization of the
economy. When moving money becomes the primary economic
activity, the end is near. Let's look at some of the symptoms.
The high frequency traders (HFTs a.k.a. "algos" or cheetah
traders) have really upped their game. The title of this section
stems from Sal Arnuk's and Joe Saluzzi's book Broken Markets,
which describes the seedy world of supercomputers skimming
enormous profits. It is consensus that HFT's are profitable for
the trading platforms but of little merit otherwise. They gum up
the system intentionally to garner advantage and dump millions
of fake quotes to be cancelled within milliseconds.24
None of this is legal, but all is tolerated. They are now
trading for razor-thin profit margins of as little as $0.00001
skim per share but making it up on volume-dangerously large
volume. One Berkshire Hathaway trade-a $120,000 per share
stock-is rumored to have netted $10 total (0.8 cents
The markets are now at great risk. We should not expect that
profiteers benefit society. We can demand that they
don't bring the entire system to its knees. I got my ten seconds
of fame in an article describing the consequences of the
legendary Flash Crash on May 6th, 2010:26
Wall Street is a crime syndicate, and I am not speaking
metaphorically... The banking system is oligarchic and the
political system has metastasized into state capitalism. The
most important market in the world-the market in which
lenders and borrowers meet to haggle over the cost of
capital-is the most manipulated market in the world.
~ David Collum, WSJ
Flash crashes are now daily occurrences, as thoroughly
documented by market research firm Nanex, and are not restricted
to any one market. India tanked 15% in a few minutes.27
The precious metals appear to be a favorite playground: "At 1:22
p.m. SLV was forced down by rapid-fire machine-generated
quotes-more than 75,000 per second."28
Berkshire Hathaway-Berkshire Hathaway!-dropped from
$120,000 a share to $1 for a few milliseconds.29
Commodity Futures Trading Commission (CFTC) commissioner Bart
Chilton says that the "third largest trader by volume at the
Chicago Mercantile Exchange (CME) is one of these cheetah
traders in Prague."30
(Bart appears to be a supporter of clean markets,
though I remain distrustful.) On August 1st, 150 stocks swung
wildly. In a heavy dose of irony, the wildest-a 40% swing-was a
company called Bunge.31
The monstrous oil market flash crashed when a 50-fold spike in
trade volume hit the tape.32
Some fear a flash crash in the unimaginably large U.S. Treasury
Irony reached a fevered pitch when BATS Global Markets
(BATS), the third largest trading platform behind NYSE and
NASDAQ, listed their own IPO.34
Their primary customers-the cheetah traders-drove the share
price from $16 to 1 cent in 900 milliseconds, forcing the
cancellation of the IPO. Knight Trading, while beta-testing
their own HFT algo, released it to the wild. While the traders
snarfed down celebratory mochaccinos, a pesky sign error caused
the HFT algo to buy high-sell low for a very
long 45 minutes.35
One of the most respected trading firms in the business was
shopping itself to potential buyers within 24 hours. The
standard excuse for erratic market behavior-Disney-like
"fat-fingered traders" hitting the wrong key on a trade-became
comical alibis for deep-seated structural flaws in the markets.
We have a huge problem. Don't take my word for it. Let's
listen to what some of the pros have to say:
All this trading creates nothing, creates no value, in
fact, subtracts from value.
~ John Bogle, inventor of the index fund
Essentially, the for-profit exchanges are approving their
own rule changes. The lunatics are now running the asylum.
~ Joe Saluzzi, cofounder of Themis Trading
High-speed trading, if we may get our two cents in, is a
dubious activity to label as a technological advance.
~ Alan Abelson, Former Editor of Barrons
Not all IPOs flash-crashed; some simply beat investors like
rented mules using more traditional methods. I had an
entertaining Twitter exchange with Sal Arnuk, cofounder of
Themis Trading and coauthor of Broken Markets, on May
18th just hours before the now-infamous Facebook IPO:
Facebook flashcrash to $0.01 would be fun and educational
for the whole family.
doubt that....prepping for weeks
The rest is history. Facebook didn't flash crash, but weeks
of prepping were inadequate. Facebook crashed the NASDAQ market
for 17 very long seconds, which is a lifetime when measured in
The high-profile Facebook IPO-technically a secondary
offering-managed to maximize Facebook's capital by selling
shares into the market near its all-time high. Underwriter
Morgan Stanley took a beating (possibly billions) defending the
opening price of $38 before watching it drop, eventually
reaching the teens. Isn't "defending shares" illegal? While
Morgan Stanley was getting hammered, the other underwriters,
Goldman Sachs and JP Morgan, were loaning shares into the market
Despite a huge outcry from those hoping for an IPO opening day
bounce, I found this all highly entertaining and a good lesson
in risk management. Investors hoping for easy money discovered
that IPO stands for "it's probably overpriced." Facebook also
spawned a cottage industry of Mad Libs (Fraudbook, Faceplant,
A lesser known IPO failure causing a stir was Ruckus (RKUS),
dropping 20% on the opening and blaming it on Hurricane Sandy.38
Splunk's (SPLK) IPO was halted after it hovered at $32 and then
plummeted to $17 on a 500-share trade.39
They eventually dropped 30% in an orderly slide. IPOs from the
not-so-distant past that continue to inflict pain include
post-IPO losses for ZYNGA (-80%), Groupon (-90%), and Pandora
(-60%). Investment-grade Beanie Babies and CPDOs sound good by
The markets are broken. It's only a matter of time before the
vernacular phrases FUBAR and SNAFU will reassert into our
language. The Tacoma Narrows Bridge as a metaphor for
instability has been around the web for years, but is well worth
paper on the profitability of high frequency traders has been attracting
a fair amount of
attention lately. Among the authors is Andrei Kirilenko of the CFTC, whose
study of the flash crash used similar data and methods to illuminate the
of trading strategies in the S&P 500 E-mini futures market. While the earlier
work examined transaction level data for four days in May 2010, the present
study looks at the entire month of August 2010. Some of the new findings are
startling, but need to be interpreted with greater care than is taken in the
High frequency traders are characterized by large volume, short holding periods,
and limited overnight and intraday directional exposure:
For each day there are three categories a potential trader must satisfy
to be considered a HFT: (1) Trade more than 10,000 contracts; (2) have an
end-of-day inventory position of no more than 2% of the total contracts
the firm traded that day; (3) have a maximum variation in inventory scaled
by total contracts traded of less than 15%. A firm must meet all three criteria
on a given day to be considered engaging in HFT for that day. Furthermore,
to be labeled an HFT firm for the purposes of this study, a firm must be
labeled as engaging in HFT activity in at least 50% of the days it trades
and must trade at least 50% of possible trading days.
Of more than 30,000 accounts in the data, only 31 fit this description. But
these firms dominate the market, accounting for 47% of total trading volume
and appearing on one or both sides of almost 75% of traded contracts. And they
do this with minimal directional exposure: average intraday inventory amounts
to just 2% of trading volume, and the overnight inventory of the median HFT
firm is precisely zero.
This small set of firms is then further subdivided into categories based on
the extent to which they are providers of liquidity. For any given trade, the
liquidity taker is the firm that initiates the transaction, by submitting an
order that is marketable against one that is resting in the order book. The
counterparty to the trade (who previously submitted the resting limit order)
is the liquidity provider. Based on this criterion, the authors partition the
set of high frequency traders into three subcategories: aggressive, mixed, and
To be considered an Aggressive HFT, a firm must... initiate at least 40%
of the trades it enters into, and must do so for at least 50% of the trading
days in which it is active. To be considered a Passive HFT a firm must initiate
fewer than 20% of the trades it enters into, and must do so for at least
50% of the trading days during which it is active. Those HFTs that meet
neither... definition are labeled as Mixed HFTs. There are 10 Aggressive,
11 Mixed, and 10 Passive HFTs.
This heterogeneity among high frequency traders conflicts with the common
claim that such firms are generally net providers of liquidity. In fact, the
authors find that "some HFTs are almost 100% liquidity takers, and these firms
trade the most and are the most profitable."
Given the richness of their data, the authors are able to compute profitability,
risk-exposure, and measures of risk-adjusted performance for all firms. Gross
profits are significant on average but show considerable variability across
firms and over time. The average HFT makes over $46,000 a day; aggressive firms
make more than twice this amount. The standard deviation of profits is five
times the mean, and the authors find that "there are a number of trader-days
in which they lose money... several HFTs even lose over a million dollars in
a single day."
Despite the volatility in daily profits, the risk-adjusted performance of high
frequency traders is found to be spectacular:
HFTs earn above-average gross rates of return for the amount of risk they
take. This is true overall and for each type... Overall, the average annualized
Sharpe ratio for an HFT is 9.2. Among the subcategories, Aggressive HFTs
(8.46) exhibit the lowest risk-return tradeoff, while Passive HFTs do slightly
better (8.56) and Mixed HFTs achieve the best performance (10.46)... The
distribution is wide, with an inter-quartile range of 2.23 to 13.89 for
all HFTs. Nonetheless, even the low end of HFT risk-adjusted performance
is seven times higher than the Sharpe ratio of the S&P 500 (0.31).
These are interesting findings, but there is a serious problem with this
interpretation of risk-adjusted performance. The authors are observing only
a partial portfolio for each firm, and cannot therefore determine the firm's
overall risk exposure. It is extremely likely that these firms are trading simultaneously
in many markets, in which case their exposure to risk in one market may be amplified
or offset by their exposures elsewhere. The Sharpe ratio is meaningful only
when applied to a firm's entire portfolio, not to any of its individual components.
For instance, it is possible to construct a low risk portfolio with a high Sharpe
ratio that is composed of several high risk components, each of which has a
low Sharpe ratio.
To take an extreme example, if aggressive firms are attempting to exploit arbitrage
opportunities between the futures price and the spot price of a fund that tracks
the index, then the authors would have significantly overestimated the firm's
risk exposure by looking only at its position in the futures market. Over short
intervals, such a strategy would result in losses in one market, offset and
exceeded by gains in another. Within each market the firm would appear to have
significant risk exposure, even while its aggregate exposure was minimal. Over
longer periods, net gains will be more evenly distributed across markets, so
the profitability of the strategy can be revealed by looking at just one market.
But doing so would provide a very misleading picture of the firms risk exposure,
since day-to-day variations in profitability within a single market can be substantial.
The problem is compounded by the fact that there are likely to by systematic
differences across firms in the degree to which they are trading in other markets.
I suspect that the most aggressive firms are in fact trading across multiple
markets in a manner that lowers rather than amplifies their exposure in the
market under study. Under such circumstances, the claim that aggressive firms
"exhibit the lowest risk-return tradeoff" is without firm foundation.
Despite these problems of interpretation, the paper is extremely valuable because
it provides a framework for thinking about the aggregate costs and benefits
of high frequency trading. Since contracts in this market are in zero net supply,
any profits accruing to one set of traders must come at the expense of others:
From whom do these profits come? In addition to HFTs, we divide the remaining
universe of traders in the E-mini market into four categories of traders:
Fundamental traders (likely institutional), Non-HFT Market Makers, Small
traders (likely retail), and Opportunistic traders... HFTs earn most of
their profits from Opportunistic traders, but also earn profits from Fundamental
traders, Small traders, and Non-HFT Market Makers.
Small traders in particular suffer the highest loss to HFTs on a per
Within the class of high frequency traders is another hierarchy: mixed firms
lose to aggressive ones, and passive firms lose to both of the other types.
The operational costs incurred by such firms include payments for data feeds,
computer systems, co-located servers, exchange fees, and highly specialized
personnel. Most of these costs do not scale up in proportion to trading volume.
Since the least active firms must have positive net profitability in order to
survive, the net returns of the most aggressive traders must therefore be substantial.
In thinking about the aggregate costs and benefits of all this activity,
it's worth bringing to mind
It is the iron law of the markets, the undefiable
rules of arithmetic: Gross return in the market, less the costs of financial
intermediation, equals the net return actually delivered to market participants.
The costs to other market participants of high frequency trading correspond
roughly to the gross profitability of this small set of firms. What about
the benefits? The two most commonly cited are price discovery and liquidity
provision. It appears that the net effect on liquidity of the most aggressive
traders is negative even under routine market conditions. Furthermore, even
normally passive firms can become liquidity takers under
stressed conditions when liquidity is most needed but in vanishing supply.
As far as price discovery is concerned, high frequency trading is based on a
information extraction from market data. This can speed up the response
to changes in fundamental information, and maintain price consistency across
related assets. But the heavy lifting as far as price discovery is concerned
is done by those who feed information to the market about the earnings potential
of publicly traded companies. This kind of research cannot (yet) be done algorithmically.
A great deal of trading activity in financial markets
is privately profitable but wasteful in the aggregate, since
it involves a shuffling of net returns with no discernible effect on production
or economic growth. Jack Hirschleifer made this
point way back in
1971, when the financial sector was a fraction of its current size. James Tobin
reiterated these concerns a decade or so later. David Glasner, who was fortunate
enough to have studied with Hirshlefier, has recently described our predicament
Our current overblown financial sector is largely built on people hunting,
scrounging, doing whatever they possibly can, to obtain any scrap of useful
information - useful, that is for anticipating a price movement that can
be traded on. But the net value to society from all the resources expended
on that feverish, obsessive, compulsive, all-consuming search for information
is close to zero (not exactly zero, but close to zero), because the gains
from obtaining slightly better information are mainly obtained at some other
trader's expense. There is a net gain to society from faster adjustment
of prices to their equilibrium levels, and there is a gain from the increased
market liquidity resulting from increased trading generated by the acquisition
of new information. But those gains are second-order compared to gains that
merely reflect someone else's losses. That's why there is clearly overinvestment
- perhaps massive overinvestment - in the mad quest for information.
To this I would add the following: too great a proliferation of information
extracting strategies is not only wasteful in the aggregate, it can also result
market instability. Any change in incentives that substantially lengthens
holding periods and shifts the composition of trading strategies towards those
that transmit rather than extract information could therefore be both stabilizing
and growth enhancing.
This is quite the mess. I'm reading lobbyist Jeff Connaughton's stunning
"Payoff: Why Wall Street Always Wins", and he goes into great detail about
his stint as chief of staff to then-Sen. Ted Kaufman (D-DE) as they tried in
vain to get the SEC to address this very issue. Quite the eye opener: Basically,
the SEC doesn't do a damned thing unless Wall Street lets them. Add to that
the fact that these trades are so complicated, so esoteric, even the traders
don't always understand them - let alone the regulators. It's a casino, and
brokers object to
even a 50-millisecond delay. Kaufman did predict a flash crash, and the
SEC did take notice - by finally agreeing to ask Wall Street for data about
these trades. Good luck with that!
Why is it important? Because it means the retail trader (you) will never,
ever get accurate information about the markets. It's being manipulated by these
high-speed trades and you'll never really know.
this Chicago Fed studyis important:
The Chicago Federal Reserve paper, How to Keep Markets Safe in the
Era of High-Speed Trading, prattled of a laundry list of the most recent
high frequency trading debacles including Knight Capital as well as others.
Yet in spite of these increasingly frequent stock market disasters, even
basic risk controls are not implemented. Why? They claim it would slow
down their trading systems.
Industry and regulatory groups have articulated best practices related
to risk controls, but many firms fail to implement all the recommendations
or rely on other firms in the trade cycle to catch an out-of-control
algorithm or erroneous
trade. In part, this is because applying risk controls before the start
of a trade can slow down an order, and high-speed trading firms are
often under enormous pressure to route their orders to the exchange
quickly so as to capture a trade at the desired price.
While the paper focuses on events, contained within is a solid example
of really bad software engineering. The Chicago Fed found
code wasn't even tested, literally changes are being made on
the fly on live production servers not just putting those trades at
risk but the entire system as well.
Another area of concern is that some firms do not have stringent
processes for the development, testing, and deployment of code used
in their trading algorithms. For example, a few trading firms interviewed
said they deploy new trading strategies quickly by tweaking
old code and placing it into production in a matter of minutes.
Perhaps financial organizations should consider hiring some real engineers
who know a thing or two about software design instead of what they are doing.
No American who is worth their salt, including those specializing in advanced
mathematics, would ever change, on the fly, algorithms on a live
server, dealing with billions of dollars.
The study also found out of whack fictional financial mathematics, referred
to as algorithms, being designed as well.
Chicago Fed staff also found that out-of-control algorithms were
more common than anticipated prior to the study and that there were
no clear patterns as to their cause. Two of the four clearing BDs/FCMs,
two-thirds of proprietary trading firms, and every exchange interviewed
had experienced one or more errant algorithms.
The report amplifies just astounding irresponsibility and engineering
incompetence. Can you imagine someone in a nuclear facility implementing
software changes on the fly? Can you imagine air traffic control
algorithms refusing to put in safety and error checks, claiming that
slows down real time air traffic routing execution?
The Chicago Fed does give some recommendations in their report:
- Limits on the number of orders that can be sent to an exchange within
a specified period of time
- A "kill switch" that could stop trading at one or more levels
- Intraday position limits that set the maximum position a firm can
take during one day
- Profit-and-loss limits that restrict the dollar value that can be
The man wrote that the financial markets had become "treacherous waters" and
suggested that the senator read "Broken Markets," which, he wrote, "exposes our
disgusting and corrupt market system today."
Joseph Saluzzi in the office of Themis Trading in New Jersey. Mr. Saluzzi
and his business partner, Sal Arnuk, wrote a book criticizing high-frequency
TICKER tape: it's an enduring image of Wall Street. The paper is gone but
the digital tape runs on, across computer and television screens. Those stock
quotations scurrying by on CNBC are, for many, the pulse of American capitalism.
But Sal L. Arnuk doesn't really believe in the tape anymore - at least not
in the one most of us see. That tape, he says, doesn't tell the whole truth.
That might come as a surprise, given that Mr. Arnuk is a professional stockbroker.
But suddenly, and improbably, he has emerged as a leading critic of the very
market in which he works. He and his business partner, Joseph C. Saluzzi, have
become the voice of those plucky souls who try to swim with Wall Street's sharks
without getting devoured.
From workaday suburban offices here, across from a Gymboree, these two men
are taking on one of the most powerful forces in finance today:
high-frequency trading. H.F.T., as it's known, is the biggest thing to hit
Wall Street in years. On any given day, this lightning-quick, computer-driven
form of trading accounts for upward of half of all of the business transacted
on the nation's stock markets.
It's a staggering development - and one that Mr. Arnuk, 46, and Mr. Saluzzi,
45, say has contributed to the hair-raising flash crashes and computer hiccups
that seem to roil the markets with alarming frequency. Many ordinary Americans
have grown wary of the stock market, which they see as the playground of Google-esque
algorithms, powerful banks and secretive, fast-money trading firms.
To which Mr. Arnuk and Mr. Saluzzi say: enough. At their Lilliputian brokerage
firm, they are tilting at the giants of high-frequency trading and warning -
loudly - of the dangers they pose. Mr. Saluzzi was the only vocal critic of
H.F.T. appointed to a 24-member federal panel that is studying the topic. Posts
from the blog that the two men write have been packaged into a book, "Broken
Markets: How High Frequency Trading and Predatory Practices on Wall Street are
Destroying Investor Confidence and Your Portfolio," (FT Press, 2012) which
was published in June. They are even getting fan mail.
But they are also making enemies.
Proponents of high-frequency trading call them embittered relics - quixotic,
old-school stockbrokers without the skills to compete in sophisticated, modern
markets. And, in a sense, those critics are right: they are throwbacks.
Both men say they wish Wall Street could go back to a calmer, simpler time,
all the way back to, say, 2004 - before the old exchange system splintered and
murky private markets sprang up and computers could send the Dow into 1,000-point
spasms. (The bottle of Tums Ultra 1000 and the back-pain medication on Mr. Arnuk's
desk here are a testament to their frustrations.)
They have proposed solutions that might seem simple to the uninitiated but
look radical to H.F.T. insiders. For instance, the two want to require H.F.T.
firms to honor the prices they offer for a stock for at least 50 milliseconds
- less than a wink of an eye, but eons in high-frequency time.
On the Friday before
Labor Day weekend, Mr. Arnuk was sitting in the office of
Trading, the brokerage firm he founded with Mr. Saluzzi a decade ago. It
is little more than a fluorescent-lit single room; the most notable decoration
is a poster signed in gold ink by the cast of "The Sopranos." Above Mr. Arnuk,
the tape scrolled by on the Bloomberg Television channel. But other numbers
danced on four computer screens on his desk. Mr. Arnuk kept moving his cursor
across those screens, punching in figures, trying to find the best price for
a customer who wanted to buy a particular stock.
His eyes scanned the stock's going price on 13 stock exchanges across the
nation. The investing public is now using so many exchanges because new regulation
and technology have rewritten the old rules and let in new players. It's not
just the Big Board or the Nasdaq anymore. It's also the likes
Mr. Arnuk then eyed the stock's price on dozens of other trading platforms
- private ones most people can't see. Known as the dark pools, they help hedge
funds and other big-money players trade in relative secrecy.
Everywhere, different prices kept flickering on the screens. Computers at
high-speed trading firms, Mr. Arnuk said, were issuing buy and sell orders and
then canceling them almost as fast, testing the market. It can be hell on human
brokers. On the tape, the stock's price was unchanged, but beneath the tape,
things were changing all the time.
"They will flicker to see who is not flickering," Mr. Arnuk said of H.F.T.
computers. "The guy who is not flickering is the idiot - the real investor."
From his desk a few feet away, Mr. Saluzzi chimed in: "That's how the game
is played now."
ON the afternoon of May 6, 2010, shortly before 3 o'clock, the stock market
plummeted. In just 15 minutes, the Dow tumbled 600 points - bringing its loss
for the day to nearly 1,000. Then, just as fast, and just as inexplicably, it
sprang back nearly 600 points, like a bungee jumper.
It was one of the most harrowing moments in Wall Street history. And for
many people outside financial circles, it was the first clue as to just how
much new technology was changing the nation's financial markets. The flash crash,
a federal report later concluded, "portrayed a market so fragmented and
fragile that a single large trade could send stocks into a sudden spiral." It
turned out that a big
mutual fund firm had sold an unusually large number of futures contracts,
setting off a feedback loop among computers at H.F.T. firms that sent the market
into a free fall.
Despite computers' many benefits - faster, cheaper trades, and mind-boggling
analytics - they have been causing problems on Wall Street for years. Technology
has fostered so-called hot money - money that quickly shifts from one stock
to another, or one market to another, always seeking higher returns. Computer-driven
program trading was developed in the 1980s and was a contributing factor in
the 1987 market crash, though it wasn't the main culprit, as many initially
Since the 2010 flash crash, mini flash crashes have occurred with surprising
regularity in a wide range of individual stocks. Last spring, a computer glitch
scuttled the initial public offering of one of the nation's largest electronic
exchanges, BATS, and computer problems at the Nasdaq stock market dogged the
I.P.O. of Facebook.
And last month, Knight Capital, a brokerage firm at the center of the nation's
stock market for almost a decade, nearly collapsed after it ran up more than
$400 million of losses in minutes, because of errant technology. It was just
the latest high-profile case of Wall Street computers gone wild.
High-frequency traders didn't cause all of these problems. But these traders
and their computers embody the escalating technological arms race raging across
The stock market establishment says the recent mishaps distract from the
enormous benefits that technology has brought. The new trading outlets have
democratized the system and made it possible to trade any time, anywhere. Competition
has forced exchanges and trading firms to reduce the commissions they charge.
George U. Sauter, chief investment officer at the mutual fund giant Vanguard,
has said the shift saved hundreds of millions of dollars for Vanguard investors.
James Angel, a professor at Georgetown University and a member of the board
of Direct Edge, said Mr. Arnuk and Mr. Saluzzi were stoking irrational fears
of a market that is providing good returns to investors. Mr. Angel compared
them to people "who gripe that their cellphone is too complicated, ignoring
the fact that 20 years ago they didn't even have a cellphone."
But Mr. Arnuk and Mr. Saluzzi say such assessments ignore the hidden costs
of high-frequency trading, particularly the market instability it can create.
They say firms that dominate the market often stop trading during times of
crisis, when they are needed the most. They also contend that ordinary investors
are paying more for their stocks, not less, because computerized traders pick
up information about stock orders and push up prices before orders can be filled.
Traders of all sorts have split orders into smaller and smaller blocks, making
it harder for everyone to complete some types of basic trades.
"They took one of the most simple processes in the world, matching up supply
and demand, and made it such a complicated labyrinth," Mr. Arnuk said.
He and Mr. Saluzzi trace the roots of the market's current travails to a
number of regulatory changes over the last two decades. But they give the starring
role to a set of rules adopted in 2007 by the Securities and Exchange Commission.
The rules are known as the Regulation National Market System, or Reg N.M.S.
Before those rules, computerized trading had been steadily growing, but the
market was still dominated by the human traders on the floor of the New York
Stock Exchange. Reg N.M.S. broke the Big Board's domination by requiring that
orders be sent to the trading platform with the best price. This seemingly small
change led to a proliferation of new platforms, like dark pools. It also put
a premium on speed, giving an advantage to firms that could place orders first
and take advantage of minuscule price differences among exchanges.
At Themis, Mr. Arnuk and Mr. Saluzzi soon noticed they were having trouble
completing what previously were easy orders. When they tried to buy stock at
the price listed on an exchange, the price would disappear almost as soon as
they entered their order. Then it would reappear - at a penny or more higher.
The two began by voicing complaints in morning notes to clients. Soon they
moved on to industry publications like Traders Magazine, then to the mainstream
In July 2009, or 10 months before the flash crash, Mr. Saluzzi squared off
on CNBC against Irene Aldridge, a prominent advocate of high-frequency trading.
Mr. Saluzzi declared that high-frequency traders could get an early peek at
buy and sell orders, giving them an edge over everyone else.
The H.F.T. crowd could simply jump in front of ordinary
investors, he said.
"There is nothing illegal about what you are doing," Mr. Saluzzi told Ms.
Aldridge. "But, you know, it is not ethical."
Ms. Aldridge was incensed.
"How dare you accuse us of being unethical - you're unethical," she shot
back. "We are cutting your margins - of brokerages like yours - because you
cannot compete, because you do not have the proper skills."
As the host, Sue Herera, tried to cut to a commercial, the two shouted backed
"Yeah, hope your computer doesn't blow up tomorrow, O.K.?" Mr. Saluzzi snarled
at Ms. Aldridge. "Make sure the fuses are O.K."
The line proved prophetic.
SAL ARNUK and Joe Saluzzi are unlikely Wall Street gadflies. Mr. Arnuk grew
up in modest surroundings in the Bay Ridge section of Brooklyn, Mr. Saluzzi
in Sheepshead Bay. They met after college in back-office jobs at Morgan Stanley
and bonded over weekend softball games and commutes. Both soon realized they
didn't have the connections to move up at a white-shoe Wall Street firm.
Talking to them now, it's clear that both have
a certain anti-establishment bent, at least as far as Wall Street is concerned.
Mr. Arnuk says he filled the wall of his dorm room at what is
now Binghamton University with rejection letters from financial firms. After
business school, their scrappy attitudes led them to computerized trading, the
upstart part of the industry in the 1990s. They
spent nearly a decade at Instinet, one of the original off exchange trading
When they struck out on their own and founded Themis in 2002, they intended
to use their technological expertise to help clients navigate the markets.
But soon enough, they say, the computers took over, with formulas pushing share
prices up and down regardless of anything happening at the underlying company.
Mr. Saluzzi acknowledges that computerized trading has hurt firms like Themis,
which executes trades on behalf of clients. Many former Themis clients now trade
via algorithms, or algos, with no human involvement. But both men say human
brokers can often navigate complex markets better than computers. Last year,
Themis's revenue was up 10 percent, despite an overall decline in trading volume,
they say. This year, revenue is holding steady.
One Themis client, Derek Laub, director of trading at Jetstream Capital,
a small investment firm just outside Nashville, says he turns to Themis because
Mr. Arnuk and Mr. Saluzzi provide a human touch, and help him avoid falling
prey to more sophisticated H.F.T. firms. Trading through Themis costs Mr. Laub
a bit more - about 1 cent a share, total - but that's still cheaper than the
3 cents or 4 cents charged by many big banks. More important, Mr. Laub says
he likes Themis because it speaks for small investment firms that don't have
the time or wherewithal to examine every problem in the market structure or
to take on the big trading firms.
"You feel like there is at least someone out there who is going to give the
other side of the argument," Mr. Laub said.
The views of Mr. Arnuk and Mr. Saluzzi are gaining more traction with industry
insiders. The head of the New York Stock Exchange
said this summer that the pursuit of speed had gone too far.
In debates with Mr. Saluzzi, some H.F.T. executives have agreed that the fragmentation
of the markets is now doing more harm than good for investors. And after the
breakdown at Knight Capital, the S.E.C. called for a round table on market technology;
it will be held on Oct. 2.
BUT Mr. Arnuk and Mr. Saluzzi do not think that big change is on the way.
For their part, they don't want to do away with computerized trading altogether
- just the frantic developments of the last few years. "I don't want to go back
to 1987, but 2004 wouldn't be so bad," Mr. Arnuk says.
Their message has won them a following among many ordinary Americans who,
rightly or wrongly, have concluded that the Wall Street game is rigged. Before
heading out for Labor Day weekend, Mr. Arnuk opened one more example of fan
mail - a letter from an Idaho man that also went to Senator Michael D. Crapo,
an Idaho Republican.
The man wrote that the financial markets had
become "treacherous waters" and suggested that the senator read "Broken Markets,"
which, he wrote, "exposes our disgusting and corrupt market system today."
Mr. Arnuk smiled. "That's going up on the wall," he said. "I consider it
a badge of honor."
A version of this article appeared
[Jul 31, 2011]
Take Stock" by By Sell
on News, a macro equities analyst.
Exactly how did we get into this mess with the capital markets?
- A situation where the global
of derivatives is over $US600 trillion, which is about twice the capital
stock of the world.
- A situation where high frequency trading
is over two thirds of the transactions on the NYSE and about the same in
the stock markets of the UK and Europe.
Likewise they are over half the action in foreign exchange markets and they
are rapidly becoming dominant in the futures market.
Andrew Haldane from the Bank of England is arguing against allowing high
frequency trading - algorithms chasing algorithms chasing algorithms - from
being allowed to proliferate pointing at volatility as the problem:
Speed increases the risk of feasts and famines
in market liquidity. HFT [high-frequency traders] contribute
to the feast through lower bid-ask spreads. But they also
contribute to the famine if their liquidity
provision is fickle in situations of stress.
Haldane noted that relative to gross domestic
product, the equity market capitalisation of the US, Europe and Asia had
not grown since 2000, suggesting that "the contribution
of equity markets to economic growth … has been static".
Little wonder, when you consider that companies are putting themselves in
the hands of algorithms.
I think this conclusion, which many come to, is to some extent a blind alley.
Because the volume of transactions is higher - when it is claimed that it adds
liquidity this is a circular argument, like saying "the more we trade the more
we trade" - it should mean that "volatility" at least on basic measures, is
lower. The trades are made around normative models so
they will tend to re-inforce those norms. Right up until the moment when
the market does not behave with regard to norms, and then they suddenly start
doing weird things, such as the so called "Flash Crash". So it is probably correct
to say that there is less volatility. It is also beside the point.
A better question is: Why do we think liquidity
is a good thing?" Answer, because it facilitates trade around
the exchange of information. "Information about
what?" one might then ask. "The company in which the investment
is being made," is the answer. Does algorithmic trading exchange information
about the performance of the company? No, it is only working off information
about trading behaviour. Ergo, it may increase "liquidity"
but it is not fulfilling the purpose of liquidity.
That kind of shift to traders working mostly off what traders do, rather
than assessing the value of what is being traded, has become an absolute plague.
It has taken over most Western financial markets. Hedging, for example, used
to be all about hedging bets to protect the underling exchanges (usually wheat,
or pork bellies or physical things). Now, hedging is all about reading behaviour,
which then leads to other hedging strategies that are based on reading the hedging
behaviour, and so on.
So the disappearing point is part of the problem. In our "anthrosphere" we
are increasingly staring at each other's navels in the financial markets, trying
to make money and sustainable wealth out of ether. That is part of the problem.
Regulators forgetting what the PURPOSE of financial markets is and instead just
trying to stay faithful to the technical explications of that purpose, or utility.
A colossal abrogation of responsibility, in other
words, fuelled by thoughtlessness or intellectual laziness (Haldane
is a notable exception).
But I think there is another problem. A growing mismatch in TIME between
financial markets and commerce or economic activity. I can remember in the currency
meltdowns of the last 20 years how the explanations in retrospect for why Russia
or Thailand or Mexico or Indonesia "deserved" what they got. They were always
plausible enough, if usually circular arguments.
But then you looked at what happened to those economies that had experienced
crises and the impact was completely out of alignment. In a matter of weeks,
there would be a massive re-rating of the currencies. No economy changes that
fast. The problems, if there were problems and sometimes it was just a trading
fiction, had usually accumulated for years. After the crises, the economies
would take years to recover from the shock. It seemed to me that the misalignment
in time is what is fundamentally wrong with this kind of financial behaviour.
The misalignment is even more extreme with high frequency trading, where
micro-seconds are the basic unit. How can the exchange of information about
a stock occur in such small periods? Obviously they can't. There is a mismatch.
Money should be aligned with what it is supposed to be representing, and that
includes aligned in its temporal structure. For
at least two decades, that alignment has been progressively picked apart, and
now it is reaching endemic proportions.
In terms of its intellectual origins, this has a lot to do with the quasi-scientific
methods used by economists and financiers. In science, time is just a dimension
of space. The point of creating scientific "rules" is to say that every TIME
the rule applies. Time, in other words, has to be eliminated as a problem.
Which is why science applies so poorly to human behaviour, because humans
are always changing in time. It is why scientific
models have extremely limited application to markets, because every time things
are different - at least in their timing. For instance, I may
reasonably conclude that the $A will fall, and be right because it will probably
revert back t a norm. But what I need to know to make money is the time it will
What one notices about all the fundamental analyses is that, while persuasive,
they are extremely limited because they don't tell you when the predicted events
will occur. Those traders who sniff "the times" often do much better.
Time, in other words, cannot be eliminated from human behaviour, it is front
Which is why I would submit that the misalignment in time between financial
market instruments and that which they are supposed to represent is not just
extremely dangerous, it is fundamentally inhuman.
But then you looked at what happened to those economies that had
experienced crises and the impact was completely out of alignment. In
a matter of weeks, there would be a massive re-rating of the currencies.
No economy changes that fast. The problems, if there were problems and
sometimes it was just a trading fiction, had usually accumulated for
years. After the crises, the economies would take years to recover from
the shock. It seemed to me that the misalignment in time is what is
fundamentally wrong with this kind of financial behaviour.
A very nice point.
One wonders what would be against executing all trades simultaneously
once every second or few seconds. The stock exchanges wouldn't like it,
obviously, as they could no longer earn money by selling colocated server
space, and neither would the banks, but it seems nice to fantasize about
stuff like that sometimes.
"Andrew Haldane from the Bank of England is arguing against
allowing high frequency trading … from being allowed to proliferate
pointing at volatility as the problem."
Well, sure, HFT has meant volatility problems, and it allows trading
absolutely detached from market fundamentals - and if that's true, what's
the point of such a stock market?
Most perniciously, however, HFT has allowed
the creation of a Potemkin stock market over the last three years, which
has in turn enabled many MSM business outlets to continually sell a 'recovering'
U.S. economy where very large numbers of Americans aren't going to the wall,
though in reality the wall is exactly where those Americans are going.
Washington and Wall Street have colluded happily on what would be recognized
- if this iteration of the technologies and techniques involved weren't
ahead of the grasp of most folks and of the regulators' brief -
as market manipulation on a massive scale.
The Zero Hedge crowd may be wacked out about many things, but on this particular
score they are right. They are right. They are right.
And it's very telling that this administration in DC seems perfectly
okay with the fact that, in return for helping to provide a (relatively)
happy-face Potemkin market, the financial industry
gets to use HFT as, effectively, another financial industry tax on real
trading, skimming millions every day from regular pension fund and mom-and-pop
As the article above notes, the main argument HFT defenders offer is that
it brings vastly greater liquidity to the market.
But what kind of liquidity? The article has vague complaints about HFT
creating 'structural mismatches' and being 'fundamentally inhuman.' No,
it's worse than that. The liquidity HFT provides is the kind that, if it
were healthcare insurance, would be healthcare insurance set up so that
just when you suffer an illness or injury and need it is precisely when
Here's an interview with as an establishment figure as you can get, a
former Nasdaq Stock Market president and thirty-year veteran of the industry
called Alfred R. Berkeley III: -
Berkeley: A recent TABB Group report said that 73 percent of trading
is attributed to high-frequency traders.… We have optimized our market for
hedge funds to make money. How do they make money? They front-run institutional
trades. Traditional long-only traders have had to go into defensive mode.'
Interviewer: 'Does high-frequency trading have an impact on the quality
of liquidity in the market?'
Berkeley: 'Of course it does. The best way to see that is to look at
the size at the inside and see how many orders are canceled when it looks
like momentum is going from the buyer to the seller. And the average trade
size is just lousy.…'
Got that? The money quote is 'see how many orders are canceled when it
looks like momentum is going from the buyer to the seller.' Better
to think of this so-called liquidity as churn.
What sort of churn is it, though? Clearly, much of the 'liquidity' high
frequency traders are adding to the mix is simply to match trades created
by other HFT traders.
Furthermore, there's no way that Goldman Sachs's Sigma X, or any of the
other HFT players can absolutely ensure that their algorithms are not trading
Really, how can GS ensure it's not trading with itself - for example,
either a different arm of GS or another batch of computers running another
In fact, insider esimates are internal order matching happens all the
time in dark pools. With Sigma X estimates being around 50 percent when
I looked in 2009.
And this is legal -
Rule 17A-7: "Exemption of Certain Purchase or Sale Transactions Between
an Investment Company and Certain Affiliated Persons Thereof.". http://www.law.uc.edu/CCL/InvCoRls/rule17a-7.html
Effectively, then, HFT players could just split their prop. desks into
two or more groups and then trade a single stock back and forth. As long
as the desired result is achieved - that is, off-loading the artificially
ramped-up shares onto third parties at the end of the day - they don't need
to care. It's the ultimate churn machine.
This is really just late stage cancer. The problem
starts with interest rates set lower than market appreciation that creates
speculative feedback loops pumping up the amount of money borrowed into
existence in order to gamble, rather than invest. Now it's
just the tail wagging the dog, as this enormous amount of leverage overwhelms
all other political and economic functions.
There are two deep factors at work.
- The advances in data processing and communication have made this
kind of hyper-speed trading possible. It
is also in its nature very desirable for those involved.
Profits over time are a function of how much you make doing something
divided by how long it takes you. If you can make money in microseconds,
even tiny amounts multiply out to huge amounts because they can be repeated
so many times. There is no way to make that
much money doing anything practical in the real world, so capital will
tend to flow to this hyper-speed trading.
- The elites in the most advanced economies have disintegrated in
place over the past few decades. They are still there, but they no longer
act in a coherent manner as elites as a whole. The different fragments
act on their own, for their own.
This also means that they are defaulting on any and all social contracts
(explicit or implicit) because there is no one there to hold up there end
of the bargain. I believe that the root cause of this is that the economy
has long needed to transition to centering on knowledge production (in a
very broad sense), but we do not yet know how to organize a society for
that purpose*. And much of the "social technology" that we have that did
work in the industrial phase just gets in the way now. The challenge we
face is so fundamental and demands qualities so different from those our
societies developed during the industrial era that we do not even realize
that we are stuck in a cul-de-sac. *
To run a knowledge-centered economy, we must do two things simultaneously:
turn the knowledge loose and appropriately motivate (compensate) those who
produce, maintain, and distribute it.
We can do one at a time, but not both. From this perspective,
much of what we now have of intellectual production
is dependent on the creation of artificial knowledge scarcity, ie ignorance.
For any Tolkien geeks, we live in an era run by orcs. What I am pointing
is the world of elves that our orcs are the poor, twisted imitation of.
There is no Sauron. It is orcs all the way to the top. We just need to re-elf.
Oh, and we live under a vile enchantment that makes many of us wonder
why our elites seem to act like orcs not elves and somehow not be able to
see that it is because they _are_ orcs.
I get to use my 2 favorite quotes.
Today's scientists have substituted mathematics for experiments,
and they wander off through equation after equation, and eventually
build a structure which has no relation to reality. – Nikola Tesla
The problems are solved, not by giving new information, but by arranging
what we have already known. Philosophy is a battle against the bewitchment
of our intelligence by means of language. – Ludwig Wittgenstein PHILOSOPHICAL
INVESTIGATIONS Part I, Aphorism 109, 3rd Edition, G.E.M. Anscombe Translation.
Needless to say, algorithms are a unnatural language, but language none
the less, which has now, through technological instrumentation, not only
bewitched our intelligence, but our economic productivity.
We have confused the ink on the page with meaning
Technology has already saved all of us, daily. Algorithms can be used as
weapons if we've allow it, that's what we should see here – not overwhelming
complexity, but a high speed shell game.
Goldman Fuchs is on the phone to the FBI to keep their proprietary tool
hidden in the corporate coffer. Consider DRM, consider all the other information
hoarding aggression from Wall Street, look at the laws they want to keep
their control, 'tis yet another sign o' the times.
Well, the article is not really too suprising but I wonder if the relatively
narrow range that the stock market has traded in 1,000 to 1,200 points or
there abouts is due to the HFT skimming the profits from the market.
After all if we are to believe the the averages the market overall should
grow by some 8% per year. (And really folks let's not let the 8% be a sticking
point it could be 2% or 5% or some other number.) And since the market has
a relatively narrow trading range the money has to go somewhere.
The article is spot on. The "wisdom of crowds"
works when each individual is out independently gathering their own information.
When the information comes not from independent research, but only from
gathering the opinions of others (or inferring opinion from behavior), feedback
distortion takes over and information becomes increasingly unreliable.
This more or less describes the markets today (Thanks, internet!). Worse,
we've automated the process of feedback distortion
with computer algorithms. The stock market, for example, no longer represents
underlying value of companies in any meaningful sense of the word.
ONE year ago, the stock market took a brief and terrifying nose-dive. Almost
a trillion dollars in wealth momentarily vanished. Shares in blue-chip companies
were traded at absurdly low prices. High-frequency traders, who use computers
to look for microscopic price differences in stocks on different exchanges and
other trading venues, stopped trading, while others immediately sold whatever
they bought, mainly to each other, in what has been called "hot potato" trading.
We haven't had a repeat of last year's "flash crash," but algorithmic trading
has caused mini-flash crashes since, and surveys suggest that most investors
and analysts believe it's only a matter of time before the Big One.
They're right to be afraid. The top cop for our financial markets remains
inexcusably blind to the activities of high-speed computer trading.
After the flash crash, the Securities and Exchange Commission moved quickly
to apply a Band-Aid in the form of circuit breakers to limit daily price moves.
Then it proposed a long-overdue consolidated audit trail, to plug the gaps in
reporting requirements that prevent the efficient tracking and policing of orders
and trades. It spent months painstakingly using antiquated methods to reconstruct
and study the trading data during the flash crash. With the Commodity Futures
Trading Commission, it convened a joint advisory committee, which presented
an array of recommendations in February. And it continued to dither.
The consequences of inaction are dire. If the average investor comes to believe
stocks are valued not on the basis of a company's expected future earnings but
on the machinations of computers trading against other computers for speed and
advantage, our stock markets will have become a casino.
The explosion in computer-based trading has occurred over the past decade
as the S.E.C. adopted rules that allowed dozens of new trading venues to compete
for stock orders and accelerated the move toward high-frequency trading, which
now accounts for 70 percent of daily stock-trading volume.
While competition has lowered trading costs and in some cases improved efficiency,
the result has been a confusing amalgam of more than 50 electronic trading networks,
some of which are designed to hide large block trades, and traditional exchanges,
which are governed by outmoded regulations that do not require full transparency.
High-frequency traders navigate this maze with ever more sophisticated technology
- and armies of computer and math specialists - to find and exploit slight price
Yes, both volume and volatility in the equity markets have been declining
in recent months, but the centrality of high-frequency trading has not diminished.
Moreover, high-frequency traders have gone beyond trading stocks to futures,
options, bonds, currencies and other asset classes - and are making incursions
in foreign markets. The next flash crash could be more pervasive than last year's,
as global asset markets become increasingly correlated through the convergence
of computer-driven trading strategies.
Why hasn't the S.E.C. acted? Defenders would say that Congressionally
imposed deadlines for instituting the Dodd-Frank overhaul of financial regulations
have overwhelmed the commission and forced it to put changes to the equity markets
on the back burner.
But the paralysis at the S.E.C. runs much deeper. It's been 20 years
since Congress gave it the authority to require large-volume traders to make
more detailed disclosures; 18 months since the commission's chairman, Mary L.
Schapiro, said it would use that authority; 13 months since the agency proposed
a rule to do so; and three months since the advisory committee recommended proceeding
with "urgency" on the audit trail.
Meanwhile, even Ms. Schapiro has publicly expressed worry that our markets
no longer adequately perform their main functions: helping companies to raise
capital to innovate and grow and helping long-term investors to contribute to
the American economy while building a retirement nest egg. Mutual fund outflows
continued unabated after the flash crash through the end of 2010, an indication
that ordinary investors are fleeing the market.
In response, the S.E.C. should work with the C.F.T.C. to establish the audit
trail, which would allow real-time monitoring of electronic trading; stop trading
venues from catering unfairly to high-speed traders at the expense of regular
investors; make high-frequency traders bear their fair share of the costs involved
in heavy, instantaneous flow of electronic messages, which would discourage
strategies to stuff the system with orders that are immediately canceled; and
rethink rules that give too much priority to the rapid-fire orders that high-frequency
traders rely upon.
More is at stake than the confidence of small investors. A survey by the
consulting firm Grant Thornton shows that
initial public offerings by small companies have declined over the past
15 years. The profits to be made in supporting small-cap stocks have dried up
as Wall Street has focused obsessively on leverage and high-volume trading.
One promising idea being floated is an experimental market, with rules tailored
to support the capitalization of the fastest-growing companies, many of them
start-ups that are drivers of job creation.
America's capital markets, once the envy of the
world, have been transformed in the name of competition that was said to benefit
investors. Instead, this has produced an almost lawless high-speed maze where
prices can spiral out of control, spooking average investors and start-up entrepreneurs
The flash crash should have sounded an alarm. Unfortunately, the regulators
are still asleep.
Edward E. Kaufman Jr. was a Democratic senator from Delaware from 2009 to
2010. Carl M. Levin, a Democratic senator from Michigan, is the chairman of
the Permanent Subcommittee on Investigations.
OK, I get the notion that Goldman wanted to go after this guy. Presumably
he stole proprietary trading software. Fine. Or not fine in Mr. Aleynikov's
What I DON'T get is how Goldman's structured finance salesmen skated away
from prosecution after knowingly selling bogus mortgage-backed securities
to customers for literally years. This was nothing short of fraud. And,
there was a conspiracy, presumably among Goldman's senior management, to
commit the fraud. Everybody on the Street knew, particularly as time went
on, that this mortgage-backed securities house of cards was going to implode.
How do we know they knew? Because they took out securities positions, meaning
derivatives, against the very same gems that they were selling. Derivatives
that would pay out once the securities that they sold went bust.
Again, I get why this poor sod is going to do time. What I don't get is
why the rest of bloody Goldman Sach's management team isn't going to be
sharing a cell with him!
Shame on the NYC prosecutor's office for going after Aleynikov without also
going after Goldman's senior management crew. Shame on them! The Goldman
management's perpetration of fraud almost brought down the global financial
system. This guy Aleynikov? His crime was petty larceny at best.
If the jury unanimously believe he intentionally stole the code for profit,
then he broke the law and should be punished.
On the other hand, high frequency and flash trading is the GREATEST financial
crime in the history of this country. Far worse than Madoff or any Ponzi
scheme because we're talking billions upon billions of dollars of millions
upon millions of hard working people (essentially the same effect as Madoff,
only it doesn't drain people of everything all at once). It is absurd a
company should be able to review trades before they're even processed and
make pennies (times many zeroes of shares). It is blatant thievery and I
don't understand (and perhaps I really don't) how this hasn't been made
Obviously the big financial houses have the money to lobby effectively,
but in the end someone has to realize it will end in financial collapse.
I assume those expensive pillows the CEO's must help them to get some sleep
at night. Cause I don't see how any human being could ethically think its
Can you define high frequency trading, please, for your readers? As I
understand it, HFT is computerized front running, making deals before the
market can see the data, and also is subject to abuse, for example, executing
numerous trades to sniff out the buyer's top price thus selling at a higher
amount than if the deal had been done in the open market where all buyers
and sellers could see the trade.
Sergey Aleynikov, a computer programmer, is accused of stealing Goldman Sach's
computer code when he left the company in July 2009. His trial is about
to begin. See "What
We Are Not Supposed To Know". The problem with the trial is neither
the defendant nor what he did or did not do. The problem is what he allegedly
stole. Many market observers are tuned into this case because they are
convinced that our markets have been overtaken by fraudulent high frequency
trading. See "The
Market Is Cornered" for a discussion on why their concerns are warranted.
Our government, through incompetence or a conflict of interest, has effectively
allowed large investment banks and hedge funds to prey on investors. Not
surprisingly, high frequency traders are doing an outstanding job in their depredations.
If one googles 'high frequency trading', he or she will see numerous articles
and videos decrying its use in ripping off mutual funds, pension funds, and
retail investors. Look at the statistically impossible consecutive winning
trading days and the obscene profits generated at the proprietary trading desks
of large Wall Street investment banks and you will understand why there is a
crime behind every fortune. Either high frequency traders are cheating
or they have developed algorithms that endow computers with psychic powers heretofore
unknown to humanity. If the village idiot can figure out that high frequency
traders must be cheating on a galactic scale, so should the Securities and Exchange
Commission. It could not be more obvious. If the SEC is not regulating
and overseeing our capital markets to ensure a level playing field, why are
they still in existence? Where are the cops?
It is a natural human reaction for Americans, who struggle every day to put
food on their table and a roof over their heads, to be incensed at the arrogance
of Wall Street firms who insist on huge salaries and bonuses no matter how much
damage they inflict on the economy. What is more difficult to stomach
is the fact that our government actively protects the interests of the banksters
at every turn. Americans see the injustice when banks are bailed out and
given guarantees that make a complete mockery of the concept of moral hazard.
Americans are offended when they see our government regulatory agencies littered
with former Wall Street employees. They seethe when they watch Wall Street
CEOs parade into and out of the White House as if they own the joint.
Americans consider it an affront when they see representatives of the major
banks sitting at the table of the Federal Reserve and dispensing advice that
serve their self-interest at the expense of Main Street Americans. See
of the Plutocrats".
By Barry Ritholtz - October 8th, 2010, 6:03AM
At one point in history, equity markets were giant discounting mechanisms,
taking in all available information about the economy, earnings, sentiment,
then spitting out future expectations of value.
The proliferation of HFT and Algo traders, according to a fascinating take
Ars Technica, has changed that. Our stock markets now behave no differently
than a giant multithreaded software application. And on May 6th, 2010, that
software app crashed:
"To be a single multithreaded app, as opposed to an unrelated collection
of multithreaded apps, the different threads must somehow interact with
one another. In other words, the threads must share and jointly modify some
kind of state.What state do the various apps and algorithms that run on
Wall Street's machines share? At the very least, every part of the market
shares the quote feed, and some parts are even more tightly coupled than
that. But let's focus on the quotes.
The price of, say, AAPL at any given moment is a numerical value that
represents the output of one set of concurrently running processes, and
it also acts as the input for another set of processes. AAPL, then, is one
of many hundreds of thousands of global variables that the market-as-software
uses for message-passing among its billions of simultaneously running threads.
Does it really matter that those threads are running on separate machines
at different institutions?
. . . [If] the market really is essentially an enormous piece of multithreaded
software, then I'm not entirely sure what kind of rabbit hole we've all
Fascinating metaphor . . .Source:
The stock market as a single, very big piece of multithreaded software
Ars Technica, October 7, 2010
Oh great. So now does one take the blue pill, or the red pill?
Unfortunately, this pretty accurately describes what I think of the market
at this point. The question then becomes that soooooo much of modern neoliberal
economic theory is based on market efficiency and perfect information getting
incorporated into market prices - if this is true, what does it mean? Can
one ever really put this genie back in the bottle?
Now, consider the fact that there is 223 Trillion in outstanding US derivative
exposure ,a record. It appears that TBTF are ganbling with our money again.
Wordwide derivative exposure is 3X us. Sleep tight, hope the computer programs
If the market is a distributed, concurrent system then it's the regulatory
agencies and exchange rules that should generally be coordinating the threads.
That being said, the threads (i.e. the market participants) should try to
ensure their own safety.
I find it difficult to get too worked up about HFT's. At the end of the
day if they occasionally introduce market inefficiency then that provides
opportunities for long-term investors. If somebody wants to sell me an asset
for a fraction of my perceived value I will be only too happy to oblige.
It just seems unfair that the rules allow market participants to yank back
quotes that are below the top of the book; orders should sweep the book.
There is nothing sinister about multi-threaded apps. Every modern web-server
is multi-threaded and the world doesn't seem the worse for the wear. The
operating system I'm working on has 632 threads running at this moment.
The computer is still functional.
The core of the problem is simply that markets are complex and the various
moving parts sometimes interact in ways that produces a surprisingly bad
outcome. The fact that we use computers is irrelevant. I'm much more disturbed
that prop trading is legal. It's like going into wal-mart and finding that
half the people in the store are all about buying goods, then returning
them 2 minutes later, over and over again.
October 8th, 2010 at 1:39 pm
The author makes some reasonable points (and, folks, the issue is the algorithms
(think cooking recipe) and the relative speed of execution (how fast the
machines are running and how quickly they are able to access and modify
data - so "choice of operating system" is really irrelevant - sorry, 2+2
doesn't get a better answer under Linux than Windows, etc.).
What would make HFT's into a large, single multithreaded application is
if their algorithms are virtually identical (otherwise one would expect
somewhat different behavior from each).
This is very possible, given that programmers and consultants move from
company to company implementing the same stuff. And, they read the same
papers, and talk to each other. And their masters want to copy all of their
This is why, in aeronautics, redundant systems are created with completely
different algorithms, so that if one fails (say, due to a programming bug),
the others can correct it before you fly into the sun.
As things (seem to) stand now, if one goes berserk, they all do.
Screw this, I'm starting my own bank.
By Barry Ritholtz - October 7th, 2010, 5:20PM
Sunday, 60 Minutes turns its eye to HFT's impact on Wall Street.
"New Jersey stock trader Manoj Narang says his firm has never had a losing
week because his super computers are fast enough to capitalize on split-second
opportunities in the market. Narang and other traders are using a legal
but controversial technique called "high-frequency trading."
It played a role in a 15-minute, 600-point market meltdown last spring
now known as the "Mini Market Crash." Correspondent Steve Kroft talks to
Narang in a rare chance to see such a business up close. He also speaks
to SEC Chair Mary Schapiro – who has high frequency trading in her regulatory
sights – and others for a "60 Minutes" report to be broadcast Sunday, Oct.
10, at 7 p.m. ET/PT.
High frequency traders rely on mathematicians and computer experts to
write electronic trading programs and they use expensive computers to run
them. Many of the country's large financial institutions do high frequency
trading and it is estimated that from 50 to 70 percent of all U.S. stock
trades are made this way. Humans are becoming less involved.
But computers can create turmoil in the market, and the results can be
devastating. The market crash last May 6 was triggered by one computer algorithm
that sold $4.1 billion of securities in a 20-minute period. The high-frequency
trading programs' response to that – buying many of them up and selling
them just as fast – exacerbated an already bad situation.
Full article at link.
How Speed Traders Are Changing Wall Street
CBS, Oct. 7, 2010
Feel like it is time to spread the market annihilation love
courtesy of "any minute now" HFT-induced flash crashes? Have no fear, Bank of
America is here. "High-frequency trading in the US and Europe has grabbed most
attention in the market, but similar activities are quietly taking off in Asia
as well." Thusly begins a pamphlet by BofA/ML's Carrie Cheung which explains
the tremendous "advantages" that HFTs offer to any local market. Not mentioned
is that these advantages include drastic market destabilization, and that the
"attention" is of the "get that thing the hell out of here" variety. At least
we get to learn some very useful facts about the proliferation of the little
bloodsucking algos in the Pacific rim such as...
- "high-frequency trading firms today account for about 20-25% of the
TSE turnover - ZH translation: the TSE will crash only one third
lower when the Flash Crash hits it"
- "the market microstructure changes introduced at the same time (i.e.
new tick sizes) cut the average spread of Nikkei 225 stocks by 25%, making
it much cheaper to trade - ZH tranlsation: in HFT jargon, trade
is a synonym for stuff cancelable quotes and/or churn",
- "The new platform allows for higher-frequency trading, where algorithms
are used to make thousands of trades in milliseconds, thereby allowing firms
to profit from tiny spreads and market imbalances." - ZH translation:
we make frontrunning fast and easy, or your Other People's Money back;
- "Furthermore, the introduction of co-location services by Japanese exchanges,
together with third-party proximity services, further enhances the platform
for high-frequency trading firms in Japan." - ZH translation: Cisco
stands to make at least one or two cents in incremental EPS by letting the
biggest market manipulators frontrun and scalp at the speed of light; judging
by its latest results, it needs it;
- "It is estimated that high-frequency trading activity will account
for 30-40% of liquidity by the end of 2010." - ZH translation:
the crash after the next, will be about half the amplitude of the May 6
- The Kospi Index Option is the world's most heavily traded derivative.
It is highly correlated with the US markets, has a low transaction
cost and hence is heavily traded by retail investors. These elements make
it an attractive market for a lot of foreign investors including the highfrequency
trading group. - ZH translation: Japanese housewives will first
all buy together, then will be all shaken out together, losing all their
money at the same time, with just Made in New York Atari making
- China is a market most foreign investors want to access, but the entry
barriers are high. However, the recent successful launch of CSI 300 futures
will no doubt make it an important market to keep an eye on. The futures
contract, while currently limited to just domestic traders, now has the
second largest turnover in the world, following Kospi. - ZH translation:
we are preparing to blow up the world.
In conclusion, use Bank of America cause their HFT expertise in setting landmines
in Asian stock markets is second to none: "Asia's markets are evolving gradually.
In addition, the region's growing economic power and upgrades in technology
will definitely make this the next hot spot for high-frequency trading."
Full two page ad of
exporting WMDs to the Pacific rim:
Up until recently, any debate between proponents and opponents of High Frequency
Trading would typically be represented by heated debates of high conviction
on either side, with discussions rapidly deteriorating into ad hominem
attacks and the producer screaming 'cut to commercial' to prevent fistfights.
Luckily, all this is about to change. In a research paper by Reginald Smith
of the Bouchet Franklin Institute in Rochester titled "Is
high-frequency trading inducing changes in market microstructure and dynamics?"
the author finds that he "can clearly demonstrate that HFT is having
an increasingly large impact on the microstructure of equity trading dynamics.
Traded value, and by extension trading volume, fluctuations are starting
to show self-similarity at increasingly shorter timescales.
Values which were once only present on the orders of several hours or days are
now commonplace in the timescale of seconds or minutes. It is important
that the trading algorithms of HFT traders, as well as those who seek to understand,
improve, or regulate HFT realize that the overall structure of trading is influenced
in a measurable manner by HFT and that Gaussian noise models of short
term trading volume fluctuations likely are increasingly inapplicable." In other
words, the author finds ample evidence that during the past decade (on the NASDAQ)
and especially since the 2005 revision of Reg NMS (on the NYSE), stock trading
increasingly demonstrates "self similar" fractal patterns, resulting in volatility
surges, recursive feedback loops, and a market structure which is increasingly
becoming a product of the actual trading mechanism. In the process, as demonstrated
by a Hurst Exponent
gravitating increasingly further away from 0.5 (i.e., Brown Noise territory),
the Markov Process
nature of stock trading is put under question, and thus the whole premise of
an efficient market has to be reevaluated. Simply said: HFT has been shown to
affect the fairness of trading.
The paper is, needless to say, a must read for everyone who has
an even passing interest in stock trading and market regulation (alas, yes,
that would mean the SEC, and Congress). And while one of the key qualities of
the paper is presenting the history and implications of High Frequency Trading,
and its rise to market dominance primarily as a result of the revision of Reg
NMS, allowing stock trading to become a free for all for every algo, and ECN/ATM
imaginable, the key findings are what makes it unique. In analyzing stochastic
processes and fractal phenomena, and concluding that the Hurst Exponent of transactions
that involve less than 1,500 shares per trade (and especially less than 250
- a distinct subdomain relegated to HFT strategies) is no longer 0.5, the author
validates the skepticism of all those who for over a year (such as Zero Hedge)
have claimed that the direct and increasing involvement of HFT is an de-evolutionary
process that is leading to increasing market fragmentation, self-sameness, destabilization,
and volatility, offset merely by allegedly improved liquidity, which incidentally
disappears on a moment's notice when the negative side-effects of HFT overwhelm
the positive, such as was the case on May 6. Furthermore, the authors find that
the type of fractal recursive feedback loops inspired by increasing HFT participation
lead to spikes in correlation: "Correlations previously only seen across
hours or days in trading time series are increasingly showing up in the timescales
of seconds or minutes." And due to the implied
fractal nature of trading
(think standing waves, fern leaves, sandy beaches, and all other goodies unleashed
upon the world courtesy of Benoit Mandelbrot), it appears investors now have
to consider such quixotic issues as
when it comes to simple trading. What is most troubling, is that micro similarities,
as postulated by non-linear theory, tend to rapidly evolve into massively scaled
topological disturbances, and thus a few simple resonant trades can rapidly
avalanche into a major market destabilizing event.... such as that seen on May
While the math of the article is a little daunting, and the author appears
to derive a peculiar satisfaction from throwing the
function in the general mathematical stew (incidentally, with the prevalent
IQ of Zero Hedge readers being sufficiently high to allow at least a valiant
effort at proving the
we hope some of our more industrious readers take it upon themselves to venture
and pocket the generous proceeds from the
Prize, for which we will be content to receive a mere pittance as a donation
for proffering this forum), the observations and conclusions are water tight:
Given the complex nature of HFT trades and the frequent opacity of firm
trading strategies, it is difficult to pinpoint exactly what about HFT causes
a higher correlation structure. One answer could be that HFT is
the only type of trading that can exhibit trades that are reactive and exhibit
feedback effects on short timescales that traditional trading generates
over longer timescales.
Another cause may be the nature of HFT strategies themselves. Most HFT strategies
can fall into two buckets Lehoczky and Schervish (2009):
(i) Optimal order execution: trades whose purpose is to
break large share size trades into smaller ones for easier execution in
the market without affecting market prices and eroding profit. There are
two possibilities here. One that the breaking down of large orders to smaller
ones approximates a multiplicative cascade which can generate self-similar
behavior over time Mandelbrot (1974). Second, the queuing of chunks of larger
orders under an M/G/1 queue could also generate correlations in the trade
flow. However, it is questionable whether the "service time", or time to
sell shares in a limit order, is a distribution with infinite variance as
this queuing model requires.
(ii) Statistical arbitrage: trades who use the properties
of stock fluctuations and volatility to gain quick profits. Anecdotally,
these are most profitable in times of high market volatility. Perhaps since
these algorithms work through measuring market fluctuations and reacting
on them, a complex system of feedback based trades could generate self-similarity
from a variety of yet unknown processes.
Since firm trade strategies are carefully guarded secrets, it is difficult
to tell which of these strategies predominate and induces most of the temporal
When it comes to the interplay of optimal order execution and statistical
arbitrage, it can easily be seen why large block splitting into child orders
could conceive a self-similar trading pattern that reverberates across the market,
in an increasingly micro-correlated and fractal marketplace. In the course of
events on May 6, it is perfectly feasible that as many mutual funds commenced
dumping large blocks of stock, assorted algorithms had to work overtime to split
these orders into millions of small trade blocks. And with statistical arbitrage
models programmed to game and front-run large order blocks by diving the intentions
of repeated micro orders, it becomes all too clear how a rapid selling event
can rapidly culminate into a bid-less environment where both the stat arb and
order execution HFT algorithms are all on the same side of the boat. Consider
the market action from the past several days as indicative of micro volume accumulation
by HFTs, which is only offset by mega volume dumping - once all the HFTs are
forced to unwind and go to cash, the actual principal liquidity providers who
in their desperation become liquidity takers, suddenly find themselves with
no recourse but to hit any bid. Which is why the NYSE explanation
of Liquidity Replenishment Points is nothing but complete BS - the market meltdown
had nothing to do with selective order routing to non-NYSE venues, and everything
to do with a fractal implosion, in which, as Nassim Taleb would explain, the
Hurst Exponent briefly went from 0.5 to infinity minus 1, and the entire
market became correlated with itself.
Of course if the paper is correct, and the empirical evidence presented in
it is sufficient to eliminate doubt, it means that in the coming years we will
have an exponentially growing number of days in which May 6-type event will
recur over and over.
The paper's conclusion:
Given the above research results, we can clearly demonstrate that HFT
is having an increasingly large impact on the microstructure of equity trading
dynamics. We can determine this through several main pieces of evidence.
First, the Hurst exponent H of traded value in short time scales (15 minutes
or less) is increasing over time from its previous Gaussian white noise
values of 0.5. Second, this increase becomes most marked, especially in
the NYSE stocks, following the implementation of Reg NMS by the SEC which
led to the boom in HFT. Finally, H > 0.5 traded value activity is clearly
linked with small share trades which are the trades dominated by HFT traffic.
In addition, this small share trade activity has grown rapidly as a proportion
of all trades. The clear transition to HFT influenced trading noise is more
easily seen in the NYSE stocks than with the NASDAQ stocks except NWSA.
The main exceptions seem to be GENZ and GILD in the NASDAQ which are less
widely traded stocks. There are values of H consistently above 0.5 but not
to the magnitude of the other stocks. The electronic nature of the NASDAQ
market and its earlier adoption of HFT likely has made the higher H values
not as recent a development as in the NYSE, but a development nevertheless.
Given the relative burstiness of signals with H > 0.5 we can also determine
that volatility in trading patterns is no longer due to just adverse events
but is becoming an increasingly intrinsic part of trading activity. Like
internet traffic Leland et. al. (1994), if HFT trades are self-similar with
H > 0.5, more participants in the market generate more volatility, not more
There are a few caveats to be recognized. First, given the limited
timescale investigated, it is impossible to determine from these results
alone what, if any, long-term effects are incorporating the short-term fluctuations.
Second, it is an open questions whether the benefits of liquidity offset
the increased volatility. Third, this increased volatility due to self-similarity
is not necessarily [TD: but very well could be as described
above] the cause of several high profile crashes in stock prices
such as that of Proctor & Gamble (PG) on May 6, 2010 or a subsequent jump
(which initiated circuit breakers) of the Washington Post (WPO) on June
16, 2010. Dramatic events due to traceable causes such as error
or a rogue algorithm are not accounted for in the increased volatility though
it does not rule out larger events caused by typical trading activities.
Finally, this paper does not investigate any induced correlations, or lack
thereof, in pricing and returns on short timescales which is another crucial
Traded value, and by extension trading volume, fluctuations are
starting to show self-similarity at increasingly shorter timescales. Values
which were once only present on the orders of several hours or days are
now commonplace in the timescale of seconds or minutes. It is important
that the trading algorithms of HFT traders, as well as those who seek to
understand, improve, or regulate HFT realize that the overall structure
of trading is influenced in a measurable manner by HFT and that Gaussian
noise models of short term trading volume fluctuations likely are increasingly
As for evidence, we refer readers to the paper itself, but in a nutshell,
the authors find that over the years, on both the NYSE (after Reg NMS revision
in 2005) and on the Nasdaq (from before, as the Nasdaq was the original spawn
of HFT strategies), as the prevalent share bucket moved from greater than 1,000
shares per trade, to 250 or less, direct evidence of increasing HFT dominance,
especially coupled with previous Tabb group evidence that over 70% of all trading
is conducted by HFT, the Hurst Exponent of all trading increasingly moved away
from 0.5, and has hit as high as 0.7 in some case: a stunning result
which puts the entire stochastic nature of stock markets in question!
(see charts below).
Charting the average size per trade since 2002:
And charting the Hurst Exponent as calculated by the authors in a variety
of Nasdaq and NYSE stocks:
We are confident that this paper will serve as the guiding light to much
more comparable research, due to the unique approach the author takes in analyzing
stock behavior. In moving away from a traditional and simplistic Gaussian frame,
Smith isolates the very nature of the problem, which like any other non-linear
system, and thus prone to Black Swanness, has to be sought in the plane of fractal
geometry. Luckily, the author provides the one elusive observation which many
market participants (at least those whose livelihoods are not tied into the
perpetuation of the destructive HFT processes) had long sensed was on the tips
of their tongues, yet the only comprehensible elucidation was the trite and
overworn "the market is broken." At least now we know that
this is a fact.
Unfortunately, as the paper requires slightly more than first grade comprehension
and math skills, it will never be read by anyone at the SEC, or those in Congress,
who are pretending to be conducting Financial Regulation Reform, when the items
described in this paper are precisely the things that any reform should be addressing.
And while we again urge everyone to read the full paper, below we present
the section of the paper that does a terrific job in explaining the arrival
of HFT, its development over the ages, and its parasitic role in market structure.
A brief history of the events leading up to high frequency trading
In 1792, as a new nation worked out its new constitution and laws, another
less heralded revolution began when several men met under a Buttonwood tree,
and later coffee houses, on Wall St. in New York City to buy and sell equity
positions in fledgling companies. An exclusive members club from the beginning,
the New York Stock Exchange (NYSE) rapidly grew to become one of the most powerful
exchanges in the world. Ironically, even the non-member curbside traders outside
the coffee houses gradually evolved into over-the-counter (OTC) traders and
later, the NASDAQ. A very detailed and colorful history of this evolution is
given in Markham and Harty (2008); Harris (2003).
Broadly, the role of the exchange is to act as a market maker for company
stocks where buyers with excess capital would like to purchase shares
and sellers with excess stock would like to liquidate their position. Several
roles developed in the NYSE to encourage smooth operation and liquidity. There
came to be several types of market makers for buyers and sellers known as brokers,
dealers, and specialists. The usual transaction involves the execution of a
limit order versus other offers. A limit order, as contrasted to a market order
which buys or sells a stock at the prevailing market rate, instructs the purchase
of a stock up to a limit ceiling or the sale of a stock down to a limit floor.
Brokers act on behalf of a third-party, typically an institutional investor,
to buy or sell stock according to the pricing of the limit order. Dealers,
also known as market-makers, buy and sell stock using their own capital, purchasing
at the bid price and selling at the ask price, pocketing the bid-ask spread
as profit. This helps ensure market liquidity. A specialist acts as either a
broker or dealer but only for a specific list of stocks that he or she
is responsible for. As a broker, the specialist executes trades from a display
book of outstanding orders and as a dealer a specialist can trade on his or
her own account to stabilize stock prices.
The great rupture in the business-as-usual came with the Great Depression
and the unfolding revelations of corrupt stock dealings, fraud, and other
such malfeasance. The Securities and Exchange Commission (SEC) was created by
Congress in 1934 by the Securities Exchange Act. Since then, it has acted as
the regulator of the stock exchanges and the companies that list on them. Over
time, the SEC and Wall Street have evolved together, influencing each other
in the process.
By the 1960s, the volume of traded shares was overwhelming the traditional
paper systems that brokers, dealers, and specialists on the floor used. A"paperwork
crisis" developed that seriously hampered operations of the NYSE and led to
the first electronic order routing system, DOT by 1976. In addition, inefficiencies
in the handling of OTC orders, also known as "pink sheets", led to a 1963 SEC
recommendation of changes to the industry which led the National Association
of Securities Dealers (NASD) to form the NASDAQ in 1968. Orders were displayed
electronically while the deals were made through the telephone through"market
makers" instead of dealers or specialists. In 1975, under the prompting of Congress,
the SEC passed the Regulation of the National Market System, more commonly known
as Reg NMS, which was used to mandate the interconnectedness of various markets
for stocks to prevent a tiered marketplace where small, medium, and large investors
would have a specific market and smaller investors would be disadvantaged. One
of the outcomes of Reg NMS was the accelerated use of technology to connect
markets and display quotes. This would enable stocks to be traded on different,
albeit connected, exchanges from the NYSE such as the soon to emerge electronic
communication networks (ECNs), known to the SEC as alternative trading systems
In the 1980s, the NYSE upgraded their order system again to SuperDot. The
increasing speed and availability computers helped enable trading of entire
portfolios of stocks simultaneously in what became known as program trading.
One of the first instances of algorithmic trading, program trading was not high-frequency
per se but used to trade large orders of multiple stocks at once. Program trading
was profitable but is now often cited as one of the largest factors behind
the 1987 Black Monday crash. Even the human systems broke down, however,
as many NASDAQ market makers did not answer the phones during the crash.
The true acceleration of progress and the advent of what is now known as
high frequency trading occurred during the 1990s. The telecommunications technology
boom as well as the dotcom frenzy led to many extensive changes. A new group
of exchanges became prominent. These were the ECN/ATS exchanges. Using new computer
technology, they provided an alternate market platform where buyers and sellers
could have their orders matched automatically to the best price without middlemen
such as dealers or brokers. They also allowed complete anonymity for buyers
and sellers. One issue though was even though they were connected to the exchanges
via Reg NMS requirements, there was little mandated transparency. In other words,
deals settled on the ECN/ATS were not revealed to the exchange. On the
flip side, the exchange brokers were not obligated to transact with an order
displayed from an ECN, even if it was better for their customer.
This began to change, partially because of revelations of multiple violations
of fiduciary duty by specialists in the NYSE. One example, similar to
the soon to be invented 'flash trading', was where they would "interposition"
themselves between their clients and the best offer in order to either
buy low from the client and sell higher to the NBBO (National Best Bid and Offer;
the best price) price or vice versa.
In 1997, the SEC passed the Limit Order Display rule to improve transparency
that required market makers to include offers at better prices than those
the market maker is offering to investors. This allows investors to know the
NBBO and circumvent corruption.
However, this rule also had the effect of requiring the exchanges to display
electronic orders from the ECN/ATS systems that were better priced. The SEC
followed up in 1998 with Regulation ATS. Reg ATS allowed ECN/ATS systems to
register as either brokers or exchanges. It also protected investors by mandating
reporting requirements and transparency of aggregate trading activity for ECN/ATS
systems once they reach a certain size.
These changes opened up huge new opportunities for ECN/ATS systems by allowing
them to display and execute quotes directly with the big exchanges. Though
they were required to report these transactions to the exchange, they gained
much more. In particular, with their advanced technology and low-latency
communication systems, they became a portal through which next generation algorithmic
trading and high frequency trading algorithms could have access to wider
markets. Changes still continued to accelerate.
In 2000, were two other groundbreaking changes. First was the decimalization
of the price quotes on US stocks. This reduced the bid-ask spreads and made
it much easier for computer algorithms to trade stocks and conduct arbitrage.
The NYSE also repealed Rule 390 which had prohibited the trading of stocks listed
prior to April 26, 1979 outside of the exchange. High frequency trading began
to grow rapidly but did not truly take off until 2005.
In June 2005, the SEC revised Reg NMS with several key mandates. Some were
relatively minor such as the Sub-Penny rule which prevented stock quotations
at a resolution less than one cent. However, the biggest change was Rule 611,
also known as the Order Protection Rule. Whereas with the Limit Order Display
rule, exchanges were merely required to display better quotes, Reg NMS Rule
611 mandated, with some exceptions, that trades are always automatically executed
at the best quote possible. Price is the only issue and not counterparty reliability,
transaction speed, etc. The opening for high frequency trading here is clear.
The automatic trade execution created the perfect environment for high speed
transactions that would be automatically executed and not sit in a queue waiting
for approval by a market maker or some vague exchange rule. The limit to trading
speed and profit was now mostly the latency on electronic trading systems.
The boom in ECN/ATS business created huge competition for exchanges causing
traditional exchanges (NYSE & Euronext) to merge and some exchanges to
merge with large ECNs (NYSE & Archipelago). In addition, the competition created
increasingly risky business strategies to lure customers. CBSX and DirectEdge
pioneered 'flash trading' on the Chicago Board of Exchange and the NYSE/NASDAQ
respectively where large limit orders would be flashed for 50 milliseconds on
the network to paying customers who could then rapidly trade in order to profit
from them before public advertisement. Many of these were discontinued in late
2009 after public outcry but HFT was already the dominant vehicle for US equity
trading as shown in figure 1. HFT thrives on rapid fire trading of small sized
orders and the overall shares/trade has dropped rapidly over the last few years
is shown in figure 2. In addition, the HFT strategy of taking advantage of pricing
signals from large orders has forced many orders off exchanges into proprietary
trading networks called 'dark pools' which get their name from the fact they
are private networks which only report the prices of transactions after the
transaction has occurred and typically anonymously match large orders without
price advertisements. These dark pools allow a safer environment for large trades
which (usually) keep out opportunistic high frequency traders. The basic structure
of today's market and a timeline of developments are given in figure 3 and figure
4. For more detailed information, see Stoll (2006); McAndrews and Stefandis
(2000); Francis et. al. (2009); Mittal (2008); Degryse et. al. (2008); Palmer
COMPUTERIZED FRONT RUNNING: HOW A COMPUTER PROGRAM DESIGNED TO SAVE THE FREE
MARKET TURNED INTO A MONSTER by Ellen Brown
April 22, 2010 |
While the SEC is busy investigating Goldman Sachs, it might want to look
into another Goldman-dominated fraud: computerized front running using high-frequency
Market commentators are fond of talking about "free market capitalism," but
according to Wall Street commentator Max Keiser, it is no more. It has morphed
into what his TV co-host Stacy Herbert calls "rigged market capitalism": all
markets today are subject to manipulation for private gain.
Keiser isn't just speculating about this. He claims to have invented one
of the most widely used programs for doing the rigging. Not that that's what
he meant to invent. His patented program was designed to take the manipulation
out of markets. It would do this by matching buyers with sellers automatically,
eliminating "front running" – brokers buying or selling ahead of large orders
coming in from their clients. The computer program was intended to remove the
conflict of interest that exists when brokers who match buyers with sellers
are also selling from their own accounts. But the program fell into the wrong
hands and became the prototype for automated trading programs that actually
facilitate front running.
Also called High Frequency Trading (HFT) or "black box trading," automated
program trading uses high-speed computers governed by complex algorithms (instructions
to the computer) to analyze data and transact orders in massive quantities at
very high speeds. Like the poker player peeking in a mirror to see his opponent's
cards, HFT allows the program trader to peek at major incoming orders and jump
in front of them to skim profits off the top. And these large institutional
orders are our money -- our pension funds, mutual funds, and 401Ks.
When "market making" (matching buyers with sellers) was done strictly by
human brokers on the floor of the stock exchange, manipulations and front running
were considered an acceptable (if morally dubious) price to pay for continuously
"liquid" markets. But front running by computer, using complex trading programs,
is an entirely different species of fraud. A minor flaw in the system has morphed
into a monster. Keiser maintains that computerized front running with HFT has
become the principal business of Wall Street and the primary force driving most
of the volume on exchanges, contributing not only to a large portion of trading
profits but to the manipulation of markets for economic and political ends.
The "Virtual Specialist": the Prototype for High Frequency Trading
Until recently, most market making was done by brokers called "specialists,"
those people you see on the floor of the New York Stock Exchange haggling over
the price of stocks. The job of the specialist originated over a century ago,
when the need was recognized for a system for continuous trading. That meant
trading even when there was no "real" buyer or seller waiting to take the other
side of the trade.
The specialist is a broker who deals in a specific stock and remains at one
location on the floor holding an inventory of it. He posts the "bid" and "ask"
prices, manages "limit" orders, executes trades, and is responsible for managing
the uninterrupted flow of orders. If there is a large shift in demand on the
"buy" side or the "sell" side, the specialist steps in and sells or buys out
of his own inventory to meet the demand, until the gap has narrowed.
This gives him an opportunity to trade for himself, using his inside knowledge
to book a profit. That practice is frowned on by the Securities Exchange Commission
(SEC), but it has never been seriously regulated, because it has been considered
necessary to keep markets "liquid."
Keiser's "Virtual Specialist Technology" (VST) was developed for the
Exchange (HSX), a web-based, multiplayer simulation in which players use
virtual money to buy and sell "shares" of actors, directors, upcoming films,
and film-related options. The program determines the true market price automatically,
by comparing "bids" with "asks" and weighting the proportion of each. Keiser
and HSX co-founder Michael Burns applied for a patent for a "computer-implemented
securities trading system with a virtual specialist function" in 1996, and
U.S. patent no. 5960176
was awarded in 1999.
But things went awry after the dot.com crash, when Keiser's company HSX Holdings
sold the VST patent to investment firm Cantor Fitzgerald, over his objection.
Cantor Fitzgerald then put the part of the program that would have eliminated
front-running on ice, just as drug companies buy up competing patents in order
to take them off the market. Instead of preventing front-running, the program
was altered so that it actually enhanced that fraudulent practice. Keiser (who
is now based in Europe) notes that this sort of patent abuse is illegal under
European Intellectual Property law.
Meanwhile, the design of the VST program remained on display at the patent
office, giving other inventors ideas. To get a patent, applicants must list
"prior art" and then prove that their patent is an improvement in some way.
The listing for Keiser's patent shows that it has been referenced by 132 others
involving automated program trading or HFT.
Since then, HFT has quickly come to dominate the exchanges. High frequency
trading firms now account for
73% of all U.S.
equity trades, although they represent only 2% of the approximately 20,000 firms
In 1998, the SEC allowed
electronic communication networks, or alternative trading systems, to become
full-fledged stock exchanges.
trading systems (ATS) are computer-automated order-matching systems that
offer exchange-like trading opportunities at lower costs but are often subject
to lower disclosure requirements and different trading rules. Computer systems
automatically match buy and sell orders that were themselves submitted through
computers. Market making that was once done with a "specialist's book" -- something
that could be examined and audited -- is now done by an unseen, unaudited "black
For over a century, the stock market was a real market, with live
traders hotly bidding against each other on the floor of the exchange. In only
a decade, floor trading has been eliminated in all but the largest exchanges,
such as the New York Stock Exchange (NYSE); and even in those markets, it now
co-exists with electronic trading.
Alternative trading systems allow just about any sizable trader to place
orders directly in the market, rather than routing them through investment dealers
on the NYSE. They also allow any sizable trader with a sophisticated HFT program
to front run trades.
Flash Trades: How the Game Is Rigged
An integral component of computerized front running is a dubious practice
trades." Flash orders are permitted by a regulatory loophole that allows
exchanges to show orders to some traders ahead of others for a fee. At one time,
the NYSE allowed specialists to benefit from an advance look at incoming orders;
but it has now replaced that practice with a "level playing field" policy that
gives all investors equal access to all price quotes. Some ATSs, however, which
are hotly competing with the established exchanges for business, have adopted
the use of flash trades to pull trading business away from the exchanges. An
incoming order is revealed (or flashed) to a trader for a fraction of a second
before being sent to the national market system. If the trader can match the
best bid or offer in the system, he can then pick up that order before the rest
of the market sees it.
The flash peek reveals the trade coming in but not the limit price – the
maximum price at which the buyer or seller is willing to trade. This is what
the HFT program figures out, and it is what gives the high-frequency trader
the same sort of inside information available to the traditional market maker:
he now gets to peek at the other player's cards. That means high-frequency traders
can do more than just skim hefty profits from other investors. They can actually
How this is done was explained by
Karl Denninger in an insightful post on Seeking Alpha in July 2009:
"Let's say that there is a buyer willing to buy 100,000 shares of BRCM with
a limit price of $26.40. That is, the buyer will accept any price up to
$26.40. But the market at this particular moment in time is at $26.10, or thirty
"So the computers, having detected via their 'flash orders' (which ought
to be illegal) that there is a desire for Broadcom shares, start to issue tiny
(typically 100 share lots) 'immediate or cancel' orders - IOCs - to sell at
$26.20. If that order is 'eaten' the computer then issues an order at $26.25,
then $26.30, then $26.35, then $26.40. When it tries $26.45 it gets no bite
and the order is immediately canceled.
"Now the flush of supply comes at, big coincidence, $26.39, and the claim
is made that the market has become 'more efficient.'
"Nonsense; there was no 'real seller' at any of these prices! This pattern
of offering was intended to do one and only one thing -- manipulate the market
by discovering what is supposed to be a hidden piece of information -- the
other side's limit price!
"With normal order queues and flows the person with the limit order would
see the offer at $26.20 and might drop his limit. But the computers are
so fast that unless you own one of the same speed you have no chance to do this
-- your order is immediately 'raped' at the full limit price! . . . [Y]ou got
screwed for 29 cents per share which was quite literally stolen by the HFT firms
that probed your book before you could detect the activity, determined your
maximum price, and then sold to you as close to your maximum price as was possible."
The ostensible justification for high-frequency programs is that they "improve
liquidity," but Denninger says, "Hogwash. They have turned the market into a
rigged game where institutional orders (that's you, Mr. and Mrs. Joe Public,
when you buy or sell mutual funds!) are routinely screwed for the benefit of
a few major international banks."
In fact, high-frequency traders may be removing liquidity from the
market. So argues
Daly in the U.K. Globe and Mail, citing Thomas Caldwell, CEO of Caldwell
"Large institutional investors know that if they start trying to push through
a large block of shares at a certain price – even if the block is broken into
many small trades on several ATSs and markets -- they can trigger a flood
of high-frequency orders that immediately move market prices to the institution's
disadvantage. . . . That's why institutions have flocked to so-called
dark pools operated by ATSs such as Instinet, and individual dealers like
Goldman Sachs. The pools allow traders to offer prices without publicly revealing
their identities and tipping their hand."
Because these large, dark pools are opaque to other investors and to regulators,
they inhibit the free and fair trade that depends on open and transparent auction
markets to work.
The Notorious Market-Rigging Ringleader, Goldman Sachs
Tyler Durden, writing on Zero Hedge, notes that the HFT game is dominated
by Goldman Sachs, which he calls "a hedge fund in all but FDIC backing." Goldman
was an investment bank until the fall of 2008, when it became a commercial bank
overnight in order to capitalize on federal bailout benefits, including virtually
interest-free money from the Fed that it can use to speculate on the opaque
ATS exchanges where markets are manipulated and controlled.
Unlike the NYSE, which is open only from 10 am to 4 pm EST daily, ATSs trade
around the clock; and they are particularly busy when the NYSE is closed, when
stocks are thinly traded and easily manipulated. Tyler Durden writes:
"[A]s the market keeps going up day in and day out, regardless of the deteriorating
economic conditions, it is just these HFT's that determine the overall market
direction, usually without fundamental or technical reason. And based on a few
lines of code, retail investors get suckered into a rising market that has nothing
to do with green shoots or some Chinese firms buying a few hundred extra Intel
servers: HFTs are merely perpetuating the same ponzi market mythology last seen
in the Madoff case, but on a massively larger scale."
HFT rigging helps explain how Goldman Sachs earned at least
$100 million per day from its trading division, day after day, on
116 out of 194 trading days through the end of September 2009. It's like taking
candy from a baby, when you can see the other players' cards.
Reviving the Free Market
So what can be done to restore free and fair markets? A step in the right
direction would be to prohibit flash trades. The SEC is proposing such rules,
but they haven't been effected yet.
Another proposed check on HFT is a Tobin
tax – a very small tax on every financial trade. Proposals for the tax range
to 1%, so small that it would hardly be felt by legitimate "buy and hold"
investors, but high enough to kill HFT, which skims a very tiny profit from
a huge number of trades.
That is what proponents contend, but a tiny tax might not actually be enough
to kill HFT. Consider Denninger's example, in which the high-frequency trader
was making not just a few pennies but a full 29 cents per trade and had an opportunity
to make this sum on 99,500 shares (100,000 shares less 5 100-lot trades at lesser
sums). That's a $28,855 profit on a $2.63 million trade, not bad for a few milliseconds
of work. Imposing a .1% Tobin tax on the $2.63 million would reduce the profit
to $26,225, but that's still a nice return for a trade that takes less time
The ideal solution would fix the problem at its source -- the price-setting
mechanism itself. Keiser says this could be done by banning HFT and installing
his VST computer program in its original design in all the exchanges. The true
market price would then be established automatically, foreclosing both human
and electronic manipulation. He notes that the shareholders of his former firm
have a good claim for voiding out the sale to Cantor Fitzgerald and retrieving
the program, since the deal was never consummated and the investors in HSX Holdings
have never received a penny for the sale.
There is just one problem with their legal claim: the paperwork proving it
was shipped to Cantor Fitzgerald's offices in the World Trade Center several
months before September 2001. Like free market capitalism itself, it seems,
the evidence has gone up in smoke.
Dear DK and Friends
For decades, professional investment advisers have continued to teach reliance
on "value investing" and "buy and hold" as long-term guides to successful investment.
Chief economists and market pundits for financial institutions continue to urge
us to keep focused on "market fundamentals" rather than sell when jostled by
disruptive events, expecting "efficient markets" to generate a "fair price"
in the whirlwind of market trading.
Your recent briefings that covered high frequency trading raised serious
doubts about these traditional concepts of how markets work in the highly computerized,
hyper trading world of today.
Dark Pools and Flash Orders
High-Frequency (HF) traders thrive on a combination of asymmetric information
advantages and extremely short-term profit objectives. Because of their high
volume activity, HF traders have information on trades taking place in the "dark
pools" of privately arranged transactions. They are also able to initiate almost
limitless "flash orders" to ascertain the depth and breadth of the market, and
identify if there are willing buyers at some level above most recent trades.
Flash orders are small "immediate or cancel" orders, valid only for microseconds
that carry little risk. By ferreting out buyer limits, HF traders have vastly
greater knowledge of all aspects of the markets' depth and breadth than individuals
or passive investors like pension plans.
HF Modus Operandi
Computerized trading dominates today's stock markets. Functioning within
that world, HF trading casts a long shadow over value investing and market-determined
prices. HF traders achieve profitability by skimming bid-ask spreads across
a vast volume of transactions conducted in increments of millionths of a second
throughout a trading day. Profitability does not depend on any assessment of
the future value of any given security. The duration of holding a share is usually
only a few seconds during which the bid-ask spread can be captured. HF traders
position themselves as an intermediary between buyer and seller, extracting
a small charge from every transaction with arguable benefit to either buyer
or seller. The bid-ask spreads may sometimes be narrowed, but the primary determinants
are the prices at which an HFT can gather and then distribute shares rapidly.
Moreover, HF traders avoid carrying a position after market close, avoiding
any exposure to the prospects of any business over night.
Skewing Market Prices
HF trading tends to be more profitable when markets are rising so that the
bid-ask spread is maximized as HF traders fill any gap between buyers and sellers.
When markets fall, there is a strong incentive to levitate markets back up to
the levels prevailing before the sag, making profitable distribution of shares
accumulated during the decline. On days of thin trading volume this can readily
be achieved by well-timed surges of buys of ETFs such as SPY (S&P 500 ETF).
Such surges can trigger automatic buy responses of the many algorithmic trading
models on which other investors and traders rely. In sum, HF trading tends to
operate with an upward market bias. While the differences may only be pennies
per day, over time this upward bias likely lifts share price above the level
that would otherwise materialize, potentially skewing true asset value.
Systemic Risk from Illusory Liquidity
HF trading tends to be less profitable during downturns, as the sale of purchased
shares becomes more difficult in a falling price environment. Broker-dealers
who are designated "market makers" are constrained by regulatory requirements
that they must stay active and provide a bid when requested. In effect, HF traders
also function as market makers but have no comparable obligations. If they sense
an aberration in trading activity, particularly an abrupt downward movement
in prices, they are free to withdraw from trading. In a rapid market decline,
their absence is likely to amplify the rate of descent. When active, their voluminous
transactions create an illusion of ample liquidity and balance between sellers
and buyers. When they step away, this illusion is instantly dispelled. Thus,
HF traders may often help moderate or smooth market volatility, but since they
retain freedom of action to withdraw at their own discretion, they pose systemic
Likelihood of Another Flash Crash
During the "flash crash" of May 6 a number of HF trading entities stepped
away and liquidity disappeared. The May 6 flash crash only lasted a few minutes
- but a future flash crash could well last much longer. In retrospect, it is
highly doubtful that May 6 was the first time a number of HF traders stepped
out. It would be irresponsible to view the May 6 flash crash as a onetime event
with extremely low probability of recurrence.
Distortion of Market Correction
The process of HF trading gives the appearance of a huge, seemingly limitless
array of buyers at any given moment, even on days of concern that markets might
be overvalued or vulnerable to negative developments like the recent euro crisis.
On such days, when traditional buyers absent themselves, negative market corrections
may be avoided, delayed, or mitigated by the levitation of HF trading. The greater
the time between true market corrections, the greater the distortion in price
and the bigger the likely correction when HF levitation ends.
Since major corrections invariably overshoot, the
outcome will likely be uglier the longer the computer-driven postponement.
Essentially, HF trading functions as a positive feedback loop. Applied scientists
and systems specialists treat positive feedback loops as inherently unstable.
Each positive response generates stepped up repetition of the same actions.
Positive feedback loops result in an ever expanding balloon, but like all balloons,
risk of bursting increases with size. Some observers suggest that the risks
of catastrophic market outcomes have become so great that regulators must ban
HF trading. Trying to reverse technological progress has never been a very successful
endeavour. Given the fundamentally different objectives of HF traders, their
unlimited freedom of action, and their apparent dependence on positive feedback
loops, regulators might be wise to devise compensating negative feedback mechanisms.
Some commentators have suggested introduction of minimum holding periods for
non broker-dealers. Alteration of incentives might be achieved by introduction
of a sliding scale of fees or taxes according to volume and speed of trading.
Or, if HF traders decide to withdraw they might not be allowed to resume trading
for a specified period of days. That at least would reduce the evident risk
of a market plunge resulting from arbitrary decisions to halt HF trading. The
goal of regulators is not to get rid of HF trading but rather to realign its
incentives to the objective of eliminating systemic risk.
All the best
Harald Malmgren and Mark Stys
Dr Harald Malmgren is Chief Executive of Malmgren Global and also currently
the Chairman of the Cordell Hull Institute in Washington, DC, a private, not-for-profit
"think tank". He is an internationally recognised expert on world trade and
investment flows who has worked for four US Presidents. His extensive personal
global network among governments, central banks, financial institutions, and
corporations provides a highly informed basis for his assessments of global
markets. At Yale University, he was a Scholar of the House and Research Assistant
to Nobel Laureate Thomas Schelling. At Oxford University, he studied under Nobel
Laureate Sir John Hicks, while earning a DPhil in Economics. After Oxford, he
began his academic career in the Galen Stone Chair in Mathematical Economics
at Cornell University. Dr Malmgren commenced his career in government service
under President John F Kennedy, working with the Pentagon in revamping the Defense
Department's military and procurement strategies. When President Lyndon B Johnson
took office, Dr Malmgren was asked to join the newly organised office of the
US Trade Representative in the President's staff, where he had broad negotiating
responsibility as the first Assistant US Trade Representative. He has also served
as principal adviser to the OECD Wise Men's Group on opening world markets,
under the chairmanship of Jean Rey, and he served as a senior adviser to President
Richard M Nixon on foreign economic policies. President Nixon then appointed
him to be the principal Deputy US Trade Representative, with the rank of Ambassador.
In this role he served Presidents Nixon and Ford as the American government's
chief trade negotiator in dealing with all nations. In 1975 Dr Malmgren left
government service, and was appointed Woodrow Wilson Fellow at the Smithsonian
Institution. From the late 1970s he managed an international consulting business,
providing advice to many corporations, banks, investment banks, and asset management
institutions, as well as to Finance Ministers and Prime Ministers of many governments
on financial markets, trade, and currencies. He has also been an adviser to
subsequent US Presidents, as well as to a number of prominent American politicians
of both parties.
Mark Stys is Chief Investment Officer of Bluemont Capital Advisers. He was
formerly a senior bond trader with Fidelity Capital Markets, ultimately appointed
Head of Fixed Income and International Strategy. He is a past member of the
NASD Fixed Income Pricing Committee and frequent presenter for the NASD Town
Hall meetings. A graduate of the United States Naval Academy, he was an aviator
in the United States Marine Corps, and continues to function as Adviser to the
United States Marine Corps' Strategic Initiatives Group.
with 54 comments
The Securities and Exchange Commission (SEC) under Mary Shapiro is trying
to escape a difficult legacy – over the past two decades, the once proud agency
was effectively captured by the very Wall Street firms it was supposed to regulate.
The SEC's case against Goldman Sachs may mark a return to a more effective
role; certainly bringing a case against Goldman took some guts. But it
is entirely possible that the Goldman matter is a one off that lacks broader
implications. And in this context the SEC's handling of concerns about
"high frequency trading" (HFT) – following the May 6 "flash crash", when the
stock market essentially shut down or rebooted for 20 minutes – is most disconcerting.
speech by Senator Ted Kaufman on this exact issue;
Regulatory capture begins when the regulator starts to see the world only
through the eyes of the regulated. Rather than taking on board views that
are critical of existing arrangements, tame regulators talk only to proponents
of the status quo (or people who want even more deregulation). This seems
to be what is happening with regard to HFT.
HFT is a big deal – perhaps as much as 70 percent of all stock trades are
now done by "black box" computer algorithms (i.e., no one really knows how these
work), and there are major open questions whether this operates in a way that
is fair for small investors. (Disclosure: in 2000-2001, I was on the
Committee on Market Information; I was concerned about
related issues, although market structure has changed a great deal over
the past 10 years.)
The technical, "fact-gathering" activities of bodies like the SEC are of
critical importance in both building an overall consensus – do we have a problem,
what should we do about it – and also in creating the basis for regulatory action
(e.g., the SEC does not even collect the data needed to understand how HFT contributed
to the May 6 disaster). And anyone who has ever put together a relatively
complicated discussion of this nature can attest that how you frame the issues
is typically decisive, i.e., what is presented as the range of reasonable alternative
On Wednesday, the SEC will hold a "market structure roundtable" to discuss
"high frequency trading, undisplayed liquidity, and the appropriate metrics
for evaluating market structure performance." But who exactly will be
at this discussion?
The names of panelists for this discussion are not yet public and probably
not yet final – but the preliminary list is far too much slanted towards proponents
of HFT (6 out of 7 seats at the table; see Senator Kaufman's speech for details),
with hardly any representation of people in the markets (e.g., "buy side" mutual
funds) who think HFT is potentially out of control or unfair. It looks
very much like someone is setting up a love fest for HFT – and a boxing match
with 6 tough guys against one lonely critic.
To be fair, after coming under heavy pressure from a leading member of the
Senate Banking Committee over the past 48 hours, the SEC is backpedaling quickly
and indicating that the panel invitations can be broadened. This is encouraging
– perhaps the agency is finally overcoming its tin ear problem.
But nothing other than a balanced panel on June 2 would be acceptable.
At the very least, the SEC needs to increase the panel to 10 people – 5 for
and 5 against. And all the issues need to be on the table – including
exactly who benefits from HFT, how much money they make in this fashion, and
whether or not long-term investors (and the broader economy) really gain from
The SEC must understand that it has a long way to go to restore its credibility.
Wednesday's quasi-hearing is an important test and many people will be watching
Written by Simon Johnson
May 28, 2010 at 6:04 am
Good Government vs. Less Government
The Consensus On Big Banks Shifts, But Not At Treasury "
Subscribe to comments with
You're way behind the curve on this Simon:
"The SEC and it's culture of regulatory capture"
May 28, 2010 at 8:28 am
Love it, LarryP.
May 28, 2010 at 12:27 pm
The SEC is more of a networking agency for lawyers who didn't get
hired by Omelveny & Myers straight out of law school.
On Wednesday President Obama attended a fundraiser for Barbara Boxer
hosted by Ann & Gordon Getty, heirs to the J. Paul Getty fortune. On
Thursday, after shaking down oil executives, Obama gave his Gulf Oil
Spill press conference.
If the boss does it, we shouldn't be surprised that the minions are
May 29, 2010 at 1:45 am
The SEC has always swallowed the myth that white shoe Wall Street
is legitimate and fraud is confined to penny stock boiler rooms. It
has completely ignored white shoe organized crime, which has long involved
the fleecing of clueless fund managers attempting to survive by chasing
yield on toxic fixed income products.
May 29, 2010 at 7:40 am
Ah, Byrne is just a whiner. He has absolutely nothing useful here
(or ever, really) – he's just obsessed about naked short selling.
There is no good evidence that "those damned shortsellers" are actually
causing damage. Much more money is extracted on the pump'n'dump side.
Most hedge funds play fair, some don't. Looking to HFs is a distraction
from the issues with real money involved. Most of the damage comes from
the banks trying to rip their customers' lungs out.
June 2, 2010 at 9:30 pm
"The money power preys on the nation in times of peace, and conspires
against it in times of adversity. It is more despotic than monarchy, more
insolent than autocracy, more selfish than bureaucracy. It denounces, as
public enemies, all who question its methods or throw light upon its crimes."
- Abraham Lincoln
"If the American people ever allow private banks to control the issue
of their money, first by inflation and then by deflation, the banks and
corporations that will grow up around them, will deprive the people of their
property until their children will wake up homeless on the continent their
- Thomas Jefferson
"When plunder becomes a way of life for a group of men living together
in society, they create for themselves in the course of time, a legal system
that authorizes it and a moral code that glorifies it."
- Frederic Bastiat – (1801-1850) in Economic Sophisms
"The world is governed by very different personages from what is imagined
by those who are not behind the scenes."
- Benjamin Disraeli, first Prime Minister of England
"It is well enough that people of the nation do not understand our banking
and monetary system, for if they did, I believe there would be a revolution
before tomorrow morning."
- Henry Ford
"We are on the verge of a global transformation. All we need is the right
major crisis and the nations will accept the New World Order."
- David Rockefeller
"The drive of the Rockefellers and their allies is to create a one-world
government combining super capitalism and communism under the same tent,
all under their control…. Do I mean conspiracy? Yes I do. I am convinced
there is such a plot, international in scope, generations old in planning,
and incredibly evil in intent."
- Congressman Larry P. McDonald, 1976, killed in the Korean Airlines 747
that was shot down by the Soviets
"Give me control of a nation's money and I care not who makes its laws."
- Mayer Amschel Bauer Rothschild
"If the people were to ever find out what we have done, we would be chased
down the streets and lynched."
- George H W Bush
"Needless to say, the President was correct. Whatever it was he said."
- Donald Rumsfeld, February 28, 2003
"Tell a lie loud enough and long enough and people will believe it."
- Adolph Hitler
May 28, 2010 at 9:04 am
May 28, 2010 at 12:27 pm
A fine list of quotations, Rene. I hope you don't mind me adding
"The process by which banks create money is so simple that the mind
-John Kenneth Galbraith
May 28, 2010 at 7:47 pm
The Libor Index is also watching the balance sheet of the euro banks
to justify future increases–at least that is what the e-mail says. Senator
Kaufman has always been ahead of the curve…. he joins a growing list of
venerable reporters (Helen Thomas earned another star at yesterday's meeting
regarding the BP oil spill, basically telling President Obama this
The Libor Index is also watching the balance sheet of the euro banks to
justify future increases
May 28, 2010 at 9:12 am
What do you think of the proposed rule issued on Wednesday, trying to
address many of the issues the SEC currently has with detecting manipulation
and gathering data?
May 28, 2010 at 9:12 am
Mr. Johnson wrote:
"The Securities and Exchange Commission (SEC) under Mary Shapiro is trying
to escape a difficult legacy – over the past two decades, the once proud
agency was effectively captured by the very Wall Street firms it was supposed
I wouldn't hold my breathe.
Obama SEC Appoints Fox To Guard Chicken Coop: Average American To Get
Screwed Like Always
Goldman exec named first COO of SEC enforcement
Oct 16, 2009
"The market watchdog agency said Friday that Adam Storch (29), vice president
in Goldman Sachs' Business Intelligence Group, is assuming the new position
of managing executive of the SEC division.
The move came as the SEC has been revamping its enforcement efforts following
the agency's failure to uncover Bernard Madoff's massive fraud scheme for
nearly two decades despite numerous red flags."
May 28, 2010 at 9:15 am
> And in this context the SEC's handling of concerns
> about "high frequency trading" (HFT) – following the
> May 6 "flash crash", when the stock market essentially
> shut down or rebooted for 20 minutes – is most
Many HFT firms continued trading on May 6th – and as the SEC has already
shown on page 27 in their 151 page opus (the 29th page in
the top 10 trading firms continued to add more liquidity during the critical
moments of May 6th then they removed, and in particular added more liquidity
than under normal conditions.
Perhaps Simon and Sen Kaufman were advocating that they blow through
their capital controls and add to positions regardless of their leverage
Other providers of liquidity (myself included) shutdown on that day,
as the anomolous conditions were too dangerous to trade, and technical issues
with ARCA caused material problems processing their data feeds in a timely
The possibility of having trades busted by exchanges (which sadly came
to pass) further thwarted other liquidity providers from staying in the
markets (and certainly on selective securities for those who continued to
broadly trade), as the possibility of having a single leg of a transaction
broken could have led to catastrophic market losses (i.e. buying Accenture
for $1.00 let alone $0.01, and then selling it for $20.00 would have been
a theoretical gain, but in practice an enormous loss as the purchase transaction
would have been cancelled leaving to a net short position established with
a price of $20.00).
The events of May 6th, as the SEC is finding (and which anyone who stops
to think about the issue would clearly understand), were caused by market
orders and stop loss orders.
No sophisticated firm (HFT or otherwise) sells shares of Accenture for
1 penny. Those types of market moves can only be caused by market orders,
which are typically issued by retail and unsophisticated institutional participants.
Against a tsunami of market orders, there is no amount of liquidity that
can be mandated from either computers of humans which will withstand the
onslaught and clean wipe of 1 side of the consolidated order book.
Perhaps Senator Kaufman does understand this and is grandstanding (it
is of course good politics), but even if he didn't, I would think any economists
who thought about market participants, their financial incentives, their
margin requirements and their risk controls would.
It may be fun to blame the machines for May 6th, and it certainly was
caused by machines – but those machines were under the control of retail
traders and ludite institutional traders, who didn't understand the effects
of a wave of market orders.
May 28, 2010 at 9:32 am
SEC To Boost Market Oversight After Flash Crash
Wed, May 26 2010
(Reuters) – "Securities regulators proposed improving market surveillance
on Wednesday by tracking stock orders across all U.S. equity markets
in real time. The measure, under development at the U.S. Securities
and Exchange Commission for months, would likely have helped the agency
piece together the brief May 6 crash in stock prices.
"It is shocking that the SEC does not have its own direct access
to market data," SEC Commissioner Luis Aguilar said at a public agency
meeting. "Most Americans assume that the SEC already has these tools
and is constantly monitoring the market."
Hindered by their inability to easily see the entire marketplace,
the SEC and other regulators are still analyzing the market swoon that
saw the Dow Jones industrial average plunge some 700 points in minutes
SEC Chairman Mary Schapiro said analyzing the events of May 6 has
been substantially more challenging and time consuming because no standardized,
automated system exists to collect data across the various trading venues,
products and market participants."
For nearly three weeks, regulators have been analyzing more than
19 billion shares of stock that were traded on May 6. They still have
been unable to pinpoint the cause of the free fall."
Blame it on Skynet :-)
May 28, 2010 at 10:54 am
so we are to accept this premise that incompetance was at the bottom
of a machine driven misunderstanding? We are to accept this from a person
who is ascerting that "many" of the HFT firms were still pumping when
the big dump short circuited?
So we are to accept your judgement that Senator Kaufamn is grandstanding
in the limelight of challenging the power brokered status quo?
With razzle dazzle certainty you tell us not to believe our experiences
because only the market experts who milk this system daily who know
how to finesse this system really know what is best for the market.
I think you might be correct about stop losses being part of the
trigger mechanism in this strategy of firestorm acquistions, but maybe
you need to stop and think about what is possible and probable when
aggressive greed is engineered by computer technology and the computer
technology goes to the most cold blooded and aggressive vultures.
HFTs have no saintly purpose on this market earth and it is an arrogant
self service to state that anyone who does not see your reduction as
truth simply dosen't understand reality. Kaufman is not grandstanding…that
is a pathetic accusation considering the courage it takes to stand alone
and fight the financial interests back from the brink of self destruction.
Alas; unlike the experienced traders who know it all, … Kaufman only
has history on his side. I will trust his integrity over others in this
political jousting arena.
The "Flash Crash" is an sufficient market term. Maybe you didn't
know that? It means that the preponderance of the market think that
your HFT strategies are too big to gamble (TBTG).
Also: the tricky business of setting up a false negative premise
to sanctify an alternative is both a formal/propositional and syllogistic
fallacy based upon an exclusionary premise. CON ARTISTS USE IT!
KEEP UP THE GREAT WORK SIMON, YOU KNOW YOUR DOING SOMEHTING RIGHT
WHEN THE KINGFISH START JUMPING.
Bruce E. Woych
May 28, 2010 at 11:33 pm
"The events of May 6th, as the SEC is finding (and which anyone who
stops to think about the issue would clearly understand), were caused
by market orders and stop loss orders."
You obviously have no idea what you're talking about.
The SEC has issued a 100 page report on the events of May 6th and
it doesn't contain any explanation for what happened.
That's because they know exactly what happened. But they don't want
us to know. It had nothing to do with "retail traders and ludite institutional
May 29, 2010 at 11:57 am
> It had nothing to do with "retail traders and
> ludite institutional traders".
Right… because the most sophisticated market participants who
you revile so much were the ones selling ETFs below fair value and
selling their shares of Accenture for 1 penny!!! Get real.
The stupidest trades which led to the drop were obviously placed
by the stupidest market participants, or those brokers who liquidated
accounts due to margin calls (which given the speed of the downturn
was probably a very small contributing factor).
Stupid prices needs stupid trades (market orders, stop loss triggered
market orders or grossly mis-priced limit orders). Stupid trades
needs stupid participants. The HFT firms are quite the opposite
This was a repeat of 1987 and 1962.
May 30, 2010 at 9:37 am
Any self-respecting software engineer has a pretty good idea how HFT
programs work at a high level. Some serious trending analysis will then
reveal the biases that exist at the detail level. Given that Wall Street
is becoming a big casino, the trick is to tip the odds slightly in your
favor. If one can supply a trigger, or set of triggers, that causes reactions
by the HFTs then there is big money to be made. To actually do this is quite
complex, however, there is enough money involved to provide serious incentive.
May 28, 2010 at 10:50 am
Keep up the good work.
Here's a bit of definitional trivia.
You say "HFT is a big deal – perhaps as much as 70 percent of all stock
trades are now done by "black box" computer algorithms (i.e., no one really
knows how these work), …"
It is probably more accurate to say that no OUTSIDERS know how these
"black boxes" work. Insiders, the people who designed the algorithms, know
exactly what is in these "black boxes" – and these designers may also think
they know how the algorithms work.
But, it's very likely, given recent experiences like the flash crash,
that these insiders really don't know EVERYTHING that should be known about
how their inventions work. And, since the insiders don't share their designs
with others, no one else can help with catching gotchas in the code.
From Wikipedia (and confirmed by my own engineering background):
"In science and engineering, a black box is a device, system or object
which can (and sometimes can only) be viewed solely in terms of its input,
output and transfer characteristics without any knowledge of its internal
workings. Almost anything might be referred to as a black box: a transistor,
an algorithm, or the human mind.
The opposite of a black box is a system where the inner components or
logic are available for inspection (such as a free software/open source
program), which is sometimes known as a white box, a glass box, or a clear
May 28, 2010 at 11:50 am
This is a very astitute observation John.
My view of your comments are actually that the end results of what
we are currently witnessing. The absence of INTEGRITY, lack of ethics,
political manipulation and GREED. They're all merging.
The Pentagon and the Current Wars
The Oil Companies and Unprecedented Pollution
Wall Street and Unbridled Corruption
The Banks and Political Dominance
Politicians and Hubris Deceit
They all seem to be coming together to build one gigantic explosion.
It's like watching a train wreck in slow motion.
Is this our Hope? The alternatives and the time are growing shorter.
May 28, 2010 at 6:04 pm
"…It's like watching a train wreck in slow motion. Is this our
Hope? The alternatives and the time are growing shorter."
Our task is to ferry wounded souls across the River of Dread
till they see the dim light of hope, at which point we stop, push
them into the water and tell them to swim.
May 28, 2010 at 8:34 pm
Actually, there are some HFT algos that are running, that no
one really understands. I am serious. I know of several, where they
run, and who is trying to control them. "Control" tends to be more
analog – watching risk indicators and dialing things in. It's kind
of scary. However, one firm that has some of these in place made
money every single day in Q1. I can't reveal who it is because it
would be deeply embarrassing to the CEO, Mr. BLANK____
June 2, 2010 at 9:42 pm
The SEC was never a proud agency. Its first head was a ruthless stock
manipulator named Joseph Kennedy.
This case came about because the pressure on the SEC was so great they
finally had to do something. Look for the Fabulous guy to get thrown under
the bus. Then, it's back to business as usual.
Brett in Manhattan
May 28, 2010 at 11:54 am
To answer Johnson's title question–"Is the SEC Still Working For Wall
St.?"–one need only take seriously Johnson's description of "regulatory
capture," namely, "Regulatory capture begins when the regulator starts to
see the world only through the eyes of the regulated. Rather than taking
on board views that are critical of existing arrangements, tame regulators
talk only to proponents of the status quo (or people who want even more
deregulation)." By "status quo" Johnson obviously means only the status
quo of the regulatory apparatus; but if the term is defined economically,
say, as "corporate capitalism, modern oligopolistic in form," then it is
obvious that the SEC is a proponent of the status quo. And if the term is
construed only as "corporate capitalism," then Johnson himself is revealed
as a proponent of the status quo–the "free market system" that he labors
to "reform," hence "save." –The "concerns" about HFT that the SEC confab
will voice will be of a piece with the "concerns" that the Better Business
Bureau voices about a 'few bad apples' in order to maintain the credibility
of business in general.(The Goldman case will follow a similar trajectory,
if history is our guide.) Of course, if the SEC follows Johnson's suggestion
and includes more critics of HFT among its interlocutors, it will indeed
gain the "credibility" that Johnson seeks–but this will in the upshot advance
the "credibility" of the oligopolistic economic status quo among the gullible,
an outcome that Johnson the reformer purports to oppose. Ergo, Prof. Johnson
should be careful of what he wishes for . . . .
May 28, 2010 at 3:25 pm
Regulatory capture, regulatory smapture! Watch how fast a regulator comes
to share the views of those he regulates when that party contributes to
the campaign coffers of the political amoeba that sponsored the regulator
in the first place. Making this whole proceedure sound as though it were
moral in someway is vintage Johnson, perhaps, but vintage naive as well.
I'd been hopeful reading Johnson fuss and fume through the "financial reform"
charade here recently, he almost gave the impression he could get angry
at times. But with this piece it looks as though he's fallen back on old
tricks. Hint: In Washington convictions are a commodity, Simon. Go lead
a general strike.
May 28, 2010 at 5:13 pm
There really is no end to all the different ways we can scr-w each other
over – and each new bit of technology just offers yet another creative scr-w…
WHY was "money" created as a SYMBOLIC FORM OF CURRENCY…?
Like it or not, we are heading back to marching all the heads of cattle
past the bank to be counted.
Too much "virtual" now for it to be real…OR SUSTAINABLE.
May 28, 2010 at 5:16 pm
We must understand that money is not created by banks. It is created
by the book-keeping system that the banks, among others, use to create
the money. Bad book-keeping creates the bad money that you correctly
call "virtual." Fix the book-keeping and you will fix the money system.
Then money will return to representing "real value."
May 29, 2010 at 6:22 am
Theoretically, the book-keeping was completed before the actual
head counting of cattle in order to fund empire extension, no?
What once had "real value" is empty and at the mercy of disintegration
by natural forces
because all funding for life-maintenance (AKA as "jobs") has
been shangheid to the war chest – can we please stop kidding ourselves?
The real "misery" that will continue for the victims of the massive
transfer of "wealth" – those dead broke who were picked off first
because they played by the rules –
will continue to come from the Judicial branch of the government
Precedent becomes "common law" and subsequent rulings" rely on
precedent. When you know you are going to break every "common law",
you already have an "ordinace" written up to protect you…
The inmates ARE in charge of the "institution"…
Well, at least we are, finally,free of psychobabble and religiosity…WAR
is the suspension of law and we are at war.
May 30, 2010 at 12:38 pm
Disgusting, hubris, depressing. Three words to describe an agency that
once defended the citizens, and is now the 'whipping boy' of wall street.
As the disclosures continue (like the recent announcement of the stacked
panel for June 2) we become more repulsed.
This is a contribution to robbing our society of its greatest asset.
OPPORTUNITY. SEC open disdain for fairness would be laughable if it were
not so pathetically Machiavellian.
May 28, 2010 at 5:51 pm
That dear departed socialist, John Kenneth Galbraith, said many things
well. Here's something he wrote about regulation:
"Regulatory bodies, like the people who comprise them…mellow, and in
old age…they become, with some exceptions, either an arm of the industry
they are regulating or senile."
May 28, 2010 at 7:00 pm
@Annie: Of course an economic system based on continual growth cannot
Take a look at steadystate.org for another approach. The Center for the
Advancement of the Steady State Economy is preparing an alternative for
when the global financial system collapses.
Pass it on.
May 28, 2010 at 8:27 pm
Thanks, Carla, I'll check it out from this perspective – having a
"formula" implies that there is agreement on what the "sustainable"
man to land ratio IS at a certain level of "luxury"…
And for even a weirder perspective – did I miss the memo announcing
that all the processes involved in huddling together atoms into the
final product – flowers – have been discovered and are programmed into
After all, flowers showed up only recently when looking at the billion
year time continuum that it took to BUILD, maintain and program Spaceship
May 29, 2010 at 12:13 pm
This post touches on a subject , that for me, is the most important for
the phoney market. That is HFT. Simon even admits know one knows how the
software works. At the least, are these proprietary programs front running
each firm's own legitimate business? Are the proprietary softwares tied
in with each other so that positions get conceded between the firms by silent
agreement when they present an anomaly?
When computer software IS the market…. a human market does not exist.
Certainly, market theory antedating the computer must be totally obsolete.
May 28, 2010 at 8:56 pm
Max Keiser – journalist, former Wall Street broker and options trader,
and inventor of the software which is now being used for high frequency
trading – claims that the big banks retroactively allocate losing trades
to their clients, and keep the winning trades for their own proprietary
trading desks …
This is the second time in the couple of weeks that Keiser has made this
allegation. When he first brought this up, Keiser said that he has first-hand
knowledge of this unlawful activity because – when he was a trader – he
and everyone else did the same thing.
May 29, 2010 at 12:42 am
Re: @ tippygolden____Excellent point,"retroactively allocate losing
trades to their clients, and keeping winning trades for their proprietary
trading desk"….? As mentioned by others – repealling of the "Uptick
Rule", and no audits of trades lost in a black box are intriqing avenues
too follow-up by the Securities, and Exchange Commission (SEC),and the
Internal Revenue Service (IRS) respectively. Stop-Losses are useless
as we all experienced during the hellish wake-up call regarding the
Asian Crises. The markets need to bring back the "Collar/5%/10% Rule",
period. Ironically, the only ones that lost big on May 6, 2010 "HFT's",
were the ETF's which trade automatically when certain criteria are met.
I'd like to mention a site referencing, "Wash Sale Rules,and Audit"
May 29, 2010 at 8:31 pm
Might this explain how the TBTFs made profits on their trading desks
61 days in a row?
May 30, 2010 at 8:50 am
The NYTimes (May 28) reports: "Goldman Sachs is looking to avoid a charge
of fraud from the Securities and Exchange Commission by coming to a settlement
over a lesser offense, The Financial Times reported."
A settlement on a criminal fraud charge must be construed as bribery.
And as such it would only serve to further re-enforce the gaming of the
macro-financial structure as epitomized by Goldman Sach's implacable self-serving
attitude. There are two components to a civil society: equitable governance,
and oversight with enforcement: laws, and policing with repercussion (prison).
As long as the Wall Street Mob continues business as usual the social structure
will corrode. Punishing Goldman Sachs does little; it is a business, not
a person. Punishing or curtailing GS's top management, and their board,
May 29, 2010 at 7:15 am
SEC's capture may date back twenty years, but be fair. Levitt and Donaldson
were earnest regulators and enforcers. The hip-pocket appointees of Bush:
big accountings' Harvey Pitt, and Ayn Randian, kisses for corporations Chris
Cox derailed the SEC intentionally. No doubt you've read GAO's May 6, 2009
report: SECURITIES AND EXCHANGE COMMISSION-Greater Attention Needed to Enhance
Communication and Utilization of Resources in the Division of Enforcement.
But for those who haven't:
Would like SJ's and JK's observation: Any perceived connection between
the ubiquitous presence of Rand acolytes in the Wall Street-Washington daisy
chain and recent acceleration of financial crises and disruptions?
May 29, 2010 at 10:42 am
Let's make things simple for all.
Without HFT desks, this market will have virtually NO volume, thus creating
wider spreads which will, in turn, lay down the groundwork for different
forms of manipulation.
So HFT programs are what keep this market(can't think of a better word)
alive. They can be likened to a life support system! I am sure that some
of these bloggers know that there are software programs out there with cool
names like 'seek and destroy" or " stealth assasin". And we just saw a small
glimpse of what these programs can do. I am almost certain that some of
this software had their algos retweaked since May 6th but thats just about
that will transpire from the flash crash.
May 29, 2010 at 1:27 pm
An interesting conjecture zack.
May 29, 2010 at 5:49 pm
This being the case, the so called market is a grifter's concoction?
If the spreads are more volatile in a real market and these phoney trades
aid in a smoother more orderly market, do we not still have a grift
. Is this the Efficient Market Hypothesis demonstrated in the real world?
Then , should HFT only be permitted to the state so that all other market
participant's are on a " equal" footing. Of course, HFT really begs
the question under such circumstances that those permitted to use HFT
are really the state anyway?
May 29, 2010 at 5:55 pm
Economics are easy to understand, but many complicate it… Free-market
competition is the driving force for giving us the best products and the
most prosperity for all… how do you think America rose from nothing only
234 years ago to become the wealthiest country on Earth in such a short
Btw, a money saving tip I've found if you have print needs… I have yet
to find print prices this low!… BrumPrint.com.
May 29, 2010 at 4:07 pm
"Economics are easy to understand, but many complicate it… "
"I would gladly repay you Tuesday for a hamburger today. "
J. Wellington Wimpy
May 29, 2010 at 5:47 pm
I think 95% this is going on and it's rampant. And although I always
listen to Keiser with the left eye squinted and the right eyebrow cocked,
I think Keiser is dead on accurate on this issue. I also think it's interesting
we never hear the boys at Zerohedge blog discuss this, we never see any
investigative reporting from Bloomberg on this. Now we have FINRA (The Financial
Industry Regulatory Authority) policing/supervising trades on the NYSE.
Are the boys at Zerohedge blog upset that FINRA is policing trades on
the NYSE now??? I wouldn't hold my breath waiting for the commentary on
that. Zerohedge only gets angry when "market-makers" steal from other "market-makers",
not when the individual investor gets F_cked.
So this is self-regulation, the financial industry watching the financial
industry. How many years do you think it will be before the SEC or others
start poking around and see the lies FINRA and the "market-makers" are up
to there??? Or will they just go the usual route and wait until it explodes
in everyone's face. I guess as long as only the small individual investor
is getting screwed it doesn't matter eh??? Just imagine each time you trade
the "market-makers" take a quarter point or 10 cents on each side of the
bid/ask trade. So it's like you're being charged commission twice and the
invisible commission of course is more than the "9.95″ they ask you for
one each trade. Or worse if you're the dimwit who needs a full-service or
May 29, 2010 at 7:37 pm
Kudos to Ted Kaufman for pointing out the "inconsistencies" in our "Financial
The arguments for big finance are complex. The arguments against not
so much. It does not take an Ivy League criminal to see the problem: The
financial markets cannot possibly be "free and fair".
HFT is a criminal endeavor on it's face. If HFT were not extremely short
term profitable, they wouldn't be doing it. They are pumping and dumping
the pension and investments of the long term investors and skimmimg the
cream. Totally undesireable for us peons, okay for the elite.
The Flash Crash is not a joke, nor is regulatory capture. The US has
a real problem with domestic criminal economic terrorist organization which
are, by far, a much more significant threat than Bin Laden.
May 29, 2010 at 10:22 pm
Sandi Rubinspan wrote:
"The US has a real problem with domestic criminal economic terrorist
organization which are, by far, a much more significant threat than
When you consider the amount widespread economic pain and suffering,
it's hard to disagree.
May 30, 2010 at 11:08 am
The SEC IS Still Working For Wall Street
May 30, 2010 at 2:42 am
Love it. The comments are now better than the posts.
May 30, 2010 at 7:17 am
Of course the SEC works for Wall Street. Government and Wall Street are
synonymous with one another.
Dodd is a corporate shill, just like Obama, but as fancy.
June 1, 2010 at 1:33 pm
Providing liquidity is a good thing & should be encouraged. But no one
*needs* millisecond or better liquidity.
It will never happen, but I'd like to see more call auctions rather than
ATS' skimming customer flow and providing rebates to "liquidity providers"
who are really just front-running…
June 2, 2010 at 9:24 pm
It may be the case that HFTs don't cause "much" harm. I think (based
on analyzing tens of thousands of trades) that HFTs have added perhaps 3bps
of cost to the typical trade – maybe 1 cent on average. But this has come
along with a fair amount of additional liquidity of sorts and is existing
in a world of steadily eroding commissions. I suspect the typical retail
investor is not harmed very much, but millions of investors are paying a
few cents to the HF guys. Institutional trades are probably screwed over
quite a bit more – they get front-run and probably are paying 10bps (this
number is guesswork, the 3bps above is accurate for retail-style flow)
June 2, 2010 at 9:55 pm
Submitted by Tyler
Durden on 05/17/2010 06:28 -0500
The reasons for last week's collapse will be probed for a long time, and likely
no firm conclusion will ever be derived, because it was caused by a confluence
of numerous factors. While there may be immediate causes for the plunge, the
one recurring reason for both that crash, and all future ones, will be dominant
role played by HFT traders as they now control market structure when they operate,
and the massive vacuum left when they decide to simply shut down when things
get too heated and there is no regulated liquidity provider backstop.
As the New York Times reports yesterday from your typical HFT bucket shop
"as the stock market began to plunge in the "flash crash," someone here walked
up to one of those computers and typed the command HF STOP: sell everything,
and shutdown." A vivid and brief summary of what we have been warning for over
a year. Also, we find out that just like Tradebot, which as "one of the biggest
high-frequency traders around, had not had a losing day in four years" that
Goldman, and all the other big banks who reported a flawless first quarter,
are now nothing but one large HFT prop shop: they push the market higher on
no volume, and when the selling in size commences they all just shut down. So
much for providing liquidity when it is needed.
From the NYT:
Above the Restoration Hardware in this Jersey Shore town, not far from
the Navesink River, lurks a Wall Street giant. Here, inside the humdrum
offices of a tiny trading firm called Tradeworx, workers in their 20s and
30s in jeans and T-shirts quietly tend high-speed computers that typically
buy and sell 80 million shares a day.
But on the afternoon of May 6, as the stock market began to plunge in the
"flash crash," someone here walked up to one of those computers and typed
the command HF STOP: sell everything, and shutdown.
Across the country, several of Tradeworx's counterparts did the same. In
a blink, some of the most powerful players in the stock market today - high-frequency
traders - went dark. The result sent chills through the financial world.
After the brief 1,000-point plunge in the stock market that day, the growing
role of high-frequency traders in the nation's financial markets is drawing
Over the last decade, these high-tech operators have become sort of a shadow
Wall Street - from New Jersey to Kansas City, from Texas to Chicago. Depending
on whose estimates you believe, high-frequency traders account for 40 to
70 percent of all trading on every stock market in the country. Some of
the biggest players trade more than a billion shares a day.
And for the closest rendering of the enlightened gambling that occurs each
and every day, now that traditional investing is long-dead, the NYT brings you
this. Observe the similarity between Tradebot's trading results and those of
of Goldman et al this quarter.
These are short-term bets. Very short. The founder of Tradebot,
in Kansas City, Mo., told students in 2008 that his firm typically held
stocks for 11 seconds. Tradebot, one of the biggest high-frequency traders
around, had not had a losing day in four years, he said.
But some in Washington wonder if ordinary investors will pay a price for
this sort of lightning-quick trading. Unlike old-fashioned specialists
on the New York Stock Exchange, who are obligated to stay in the market
whether it is rising or falling, high-frequency traders can walk away at
While market regulators are still trying to figure out what happened on
May 6, the decision of high-frequency traders to withdraw from the marketplace
is under examination.
Did their decision create a market vacuum that caused prices to plunge even
"We don't know, but isn't that the point? How are we ever going
to find out what's going on with these high-frequency traders?" said Senator
Edward E. Kaufman, Democrat of Delaware, who wants the Securities and Exchange
Commission to collect more information on high-frequency traders.
The HFT response: more of the same lies we have grown accustomed to reading
from the HFT lobby.
"We are not a no-regulation crowd," said Richard Gorelick, a co-founder
of the high-frequency trading firm RGM Advisors in Austin, Tex. "We were
all created by good regulation, the regulation that provided for more competition,
more transparency and more fairness."
But critics say the markets have become unfair to investors who cannot invest
millions in high-tech computers. The exchanges offer incentives, including
rebates, which can add up to meaningful profits for high-volume traders
"The market structure has morphed from one that was equitable and fair to
one where those who get the greatest perks, who have the speed, have all
of the advantages," said Sal Arnuk, who runs an equity trading firm in New
And let's not forget that old broken record and now completely discredited
standby: providing liquidity. Sure, when all the HFTs shut down at
the same time as soon as the house of cards mirage is evident for all to see,
liquidity is gone faster than any credibility this market may have.
"The benefits of the liquidity that we bring to the markets aren't theoretical,"
said Cameron Smith, the general counsel for high-frequency trading firm
Quantlab Financial in Houston. "If you can buy a security with the knowledge
that you can resell it later, that creates a lot of confidence in the market."
The high-frequency club consisting of 100 to 200 firms are scattered far
from the canyons of Wall Street. Most use their founders' money to trade.
A handful are run from spare bedrooms, while others, like GetCo in Chicago,
have hundreds of employees.
Most of these firms typically hold onto stocks for a few seconds, minutes
or hours and usually end the day with little or no position in the market.
Their profits come in slivers of a penny, but they can reap those incremental
rewards over and over, all day long.
A quick glimpse into the "sophisticated" work that goes into picking winners
The Tradeworx computers get price quotes from the exchanges, decide how
to trade, complete a risk analysis and generate a buy or sell order - in
The computers trade in and out of individual stocks, indexes and exchange-traded
funds, or E.T.F.'s, all day long. Mr. Narang, for the most part, has no
idea which stocks Tradeworx is buying or selling.
Showing a computer chart to a visitor, Mr. Narang zeroes in on one stock
that had recently been a winner for the firm. Which stock? Mr. Narang clicks
on the chart to bring up the ticker symbol: NETL. What's that? Mr. Narang
clicks a few more times and answers slowly: "NetLogic Microsystems." He
shrugs. "Never heard of it," he says.
And here is what will happen every single time when panicked volume selling
picks up: the liquidity will always disappear, as long as HFT's role in market
structure is not curbed and regulated.
Mr. Narang said Tradeworx could not tell whether something was wrong
with the data feeds from the exchanges. More important, Mr. Narang worried
that if some trades were canceled - as, indeed, many were - Tradeworx might
be left holding stocks it did not want.
It's all good as long as the market rises without any participation. 401k
holders are happy. However as the market is up on nothing but ultra short-term
gambling by firms that have no clue what the stocks they churn daily, the days
to the next massive crash are already counting down.
on Mon, 05/17/2010 - 06:32
> "Tradebot, one of the biggest high-frequency traders around, had not
had a losing day in four years, he said."
Stop the presses. What!? Holy shit!
on Mon, 05/17/2010 - 06:41
And they don't even know what they're trading. Abandon
Rajiv Sethi doesn't understand the logic behind the decision by Nasdaq and the
New York Stock Exchange to cancel some trades that were made during last week's
plunge in the stock market:
Algorithmic Trading and Price Volatility, by Rajiv Sethi: Yesterday's
dramatic decline and rapid recovery in stock prices may have been triggered
by an erroneous trade, but could not have occurred on this scale if it were
not for the increasingly widespread use of high frequency
Algorithmic trading can be based on a variety of different strategies
but they all share one common feature: by using market data as an input,
they seek to exploit failures of (weak form) market efficiency. Such strategies
are necessarily technical and, for reasons discussed in an
earlier post, are most effective when they are rare. But they have become
increasingly common recently, and now account for
three-fifths of total volume in US equities... This is a recipe for
[In] a market dominated by technical analysis, changes in prices and
other market data will be less reliable indicators of changes in information
regarding underlying asset values. The possibility then arises of market
instability, as individuals respond to price changes as if they were
informative when in fact they arise from mutually amplifying responses
Under such conditions, algorithmic strategies can suffer heavy losses.
They do so not because of "computer error" but because of the faithful execution
of programs that are responding mechanically to market data. The
decision by Nasdaq to "cancel trades of 286 securities that fell or
rose more than 60 percent from their prices at 2:40 p.m." might therefore
be a mistake: it protects such strategies from their own flaws and allows
them to proliferate further. Canceling trades can be justified in response
to genuine human or machine error, but not in response to the implementation
of flawed algorithms.
I don't know how the losses and gains from yesterday's turmoil were distributed
among algorithmic traders and other market participants, but it is conceivable
that part of the bounce back was driven by individuals who were alert to
fundamental values and recognized a buying opportunity. ...
I would be very interested to know whether the transfer of wealth that
took place yesterday as prices plunged and then recovered resulted in major
losses or gains for the funds using algorithmic trading strategies. I expect
that those engaged in cross-market or spot-futures arbitrage would have
profited handsomely, at the expense of those relying on some form of momentum
based strategies. If so, then the cancellation of trades will simply set
the stage for a recurrence of these events sooner rather than later. ...
I agree - I don't understand the logic behind the decision to cancel the
trades either. However, Donald Marron says there's merit to both sides of the
argument, and attempts to find a compromise:
Advice to Nasdaq and the NYSE: Cancel Only 90% of the "Erroneous" Trades,
by Donald Marron: Nasdaq and the New York Stock Exchange have both announced
that they will cancel many trades made during the temporary market meltdown
between 2:40 and 3:00 last Thursday afternoon (see, for example,
from Reuters). These "erroneous" trades include any that were executed
at a price more than 60% away from their last trade as of 2:40.
The motivation for these cancellations is clear: a sudden absence of
liquidity meant that many stocks (and exchange-traded funds) temporarily
traded at anomalous prices that no rational investor would have accepted.
As several analysts have noted, however, canceling these trades creates
perverse incentives. It rewards the careless and stupid, while penalizing
the careful and smart. It protects market participants who naively expected
that deep liquidity would always be there for them, while eliminating any
benefits for the market participants who actually were willing to provide
that liquidity in the midst of the turmoil. ...
I see merit in both sides of this argument. My economist side thinks
people should be responsible for their actions and bear the costs and benefits
accordingly. But my, er, human side sees merit in protecting people from
trades that seem obviously erroneous.
What's needed is a compromise–one that maintains good incentives for
stock buyers and sellers, but provides protection against truly perverse
Happily, the world of insurance has already taught us how to design such
compromises: what we need is coinsurance. People have to have some skin
in the game, otherwise they become too cavalier about costs and risks. ...
Even a little skin in the game gets people to pay attention to what they
So here is my proposal: NYSE and Nasdaq should cancel only 90%
of each erroneous trade. The other 10% should still stand.
If Jack the Algorithmic Trader sold 100,000 shares of Accenture for $1.00
last Thursday, he should be allowed to cancel 90,000 shares of that order.
But the other 10,000 shares should stand–as a reminder to Jack (and his
boss) of his error and as a reward to Jill the Better Algorithmic Trader
who was willing to buy stocks in the midst of the confusion.
When you lose money in the stock market, even for trades that are obviously
based upon and erroneous strategy after the fact, do you get a Mulligan? I must
be missing something here, can someone explain why these trades should be canceled?
The NY Times has blown the cover off the dark art known as "HFT", or "High-Frequency
Trading", perhaps without knowing it.
It was July 15, and Intel, the computer
chip giant, had reporting robust earnings the night before. Some investors,
smelling opportunity, set out to buy shares in the semiconductor company
Broadcom. (Their activities were described
by an investor at a major Wall Street firm who spoke on the condition of
anonymity to protect his job.) The slower traders faced a quandary: If they
sought to buy a large number of shares at once, they would tip their hand
and risk driving up Broadcom's price. So, as is often the case on Wall Street,
they divided their orders into dozens of small batches, hoping to cover
their tracks. One second after the market opened, shares of Broadcom started
changing hands at $26.20.
The slower traders began issuing buy orders. But rather than being shown
to all potential sellers at the same time, some of those orders were most
likely routed to a collection of high-frequency traders for just 30 milliseconds
- 0.03 seconds - in what are known as flash orders. While markets are supposed
to ensure transparency by showing orders to everyone simultaneously, a loophole
in regulations allows marketplaces like Nasdaq to show traders some orders
ahead of everyone else in exchange for a fee.
In less than half a second, high-frequency traders gained a valuable
insight: the hunger for Broadcom was growing. Their computers began buying
up Broadcom shares and then reselling them to the slower investors at higher
prices. The overall price of Broadcom began to rise.
Soon, thousands of orders began flooding the markets as high-frequency
software went into high gear. Automatic programs began issuing and
canceling tiny orders within milliseconds to determine how much the
slower traders were willing to pay. The high-frequency computers
quickly determined that some investors' upper limit was $26.40.
The price shot to $26.39, and high-frequency programs began offering to
sell hundreds of thousands of shares.
But then the NY Times gets the bottom line wrong:
The result is that the slower-moving investors paid $1.4 million
for about 56,000 shares, or $7,800 more than if they had been
able to move as quickly as the high-frequency traders.
No. The disadvantage was not speed. The disadvantage was that the "algos"
had engaged in something other than what their claimed purpose is in the marketplace
- that is, instead of providing liquidity, they intentionally probed
the market with tiny orders that were immediately canceled in a scheme to gain
an illegal view into the other side's willingness to pay.
Let me explain.
Let's say that there is a buyer willing to buy 100,000 shares of BRCM with
a limit price of $26.40. That is, the buyer will accept any price up
But the market at this particular moment in time is at $26.10, or thirty
So the computers, having detected via their "flash orders" (which ought to
be illegal) that there is a desire for Broadcom shares, start to issue tiny
(typically 100 share lots) "immediate or cancel" orders - IOCs - to sell at
$26.20. If that order is "eaten" the computer then issues an order at $26.25,
then $26.30, then $26.35, then $26.40. When it tries $26.45 it gets no bite
and the order is immediately canceled.
Now the flush of supply comes at, big coincidence, $26.39, and the claim
is made that the market has become "more efficient."
Nonsense; there was no "real seller" at any of these prices! This pattern
of offering was intended to do one and only one thing - manipulate the market
by discovering what is supposed to be a hidden piece of information
- the other side's limit price!
With normal order queues and flows the person with the limit order would
see the offer at $26.20 and might drop his limit. But the computers
are so fast that unless you own one of the same speed you have no chance to
do this - your order is immediately "raped" at the full limit price! You got
screwed, as the fill price is in fact 30 cents a share away from where the market
A couple of years ago if you entered a limit order for $26.40 with the market
at $26.10 odds are excellent that most of your order would have filled down
near where the market was when you entered the order - $26.10. Today, odds are
excellent that most of your order will fill at $26.39, and the HFT firms will
claim this is an "efficient market." The truth is that you got screwed for 29
cents per share which was quite literally stolen by the HFT firms that probed
your book before you could detect the activity, determined your maximum price,
and then sold to you as close to your maximum price as was possible.
If you're wondering how this ramp job happened in the last week and a half,
you just discovered the answer. When there are limit orders beyond the market
outstanding against a market that is moving higher the presence of these
programs will guarantee huge profits to the banks running them and they also
guarantee both that the retail buyers will get screwed as the market will move
MUCH faster to the upside than it otherwise would.
Likewise when the market is moving downward with conviction we will see the
opposite - the "sell stops" will also be raped, the investor will also get screwed,
and again the HFT firms will make an outsize profit.
These programs were put in place and are allowed under the claim that they
"improve liquidity." Hogwash. They have turned the market into a rigged game
where institutional orders (that's you, Mr. and Mrs. Joe Public, when you buy
or sell mutual funds!) are routinely screwed for the benefit of a few major
If you're wondering how Goldman Sachs and other "big banks and hedge funds"
made all their money this last quarter, now you know. And while you may
think this latest market move was good for you, the fact of
the matter is that you have been severely disadvantaged by these "high-frequency
trading" programs and what's worse, the distortion that is presented by these
"ultra-fast" moves has a nasty habit of asserting itself in an ugly snapback
a few days, weeks or months later - in the opposite direction.
The amount of "slippage" due to these programs sounds small - a few cents
per order. It is. But such "skimming" is exactly like paying graft to a politician
or "protection money" to the Mafia - while the amount per transaction may be
small the fact of the matter is that it is not supposed to happen, it does not
promote efficient markets, it does not add to market liquidity, the "power"
behind moves is dramatically increased by this sort of behavior and market manipulation
is supposed to be both a civil and criminal violation of the law.
While the last two weeks have seen this move the market up, the same sort
of "acceleration" in market behavior can and will happen to
the downside when a downward movement asserts itself, and I guarantee that you
won't like what that does to your portfolio. You saw an example
of it last September and October, and then again this spring. As things stand
it will happen again.
This sort of gaming of the system must be stopped. Trading
success should be a matter of being able to actually determine the prospects
of a company and its stock price in the future - that is, actually trade. What
we have now is a handful of big banks and funds that have figured out ways around
the rules that are supposed to prohibit discovery of the maximum price that
someone will pay or the minimum they will sell at by what amounts to a sophisticated
Since it appears obvious that the exchanges will not police the behavior
of their member firms in this regard government must step in
and unplug these machines - all of them - irrespective of whether they are moving
the market upward or downward. While many people think they "benefited" from
this latest market move, I'm quite certain you won't like it if and when the
move is to the downside and the mutual fund holdings in your 401k and IRA get
shredded (again) by what should be prohibited and in fact result in indictments,
About the author: Karl
Optimistic about precious metals, energy, agriculture and China for the next
several years. Pessimistic about financials, commercial real estate, airlines,
Europe and the USA for the next several years. More inclined to hang my hat
with Jim Rogers than with Jim Chanos. Generally more comfortable...
"They intentionally probed the market with tiny orders that were immediately
canceled in a scheme to gain an illegal view into the other side's willingness
to pay." Talk about a f**king license to steal. Not only with the government's
cooperation, but with the government's support and encouragement. And people
say the game isn't loaded. I'm not certain whether I'd rather trade for Goldman
or have an advance copy of tomorrow's lottery numbers. Probably not much difference
in the two. What a crock of sh#t.
2009 Jul 24 10:57 AM
Reply -- Report abuse
Iconoclast421 has yet to provide a bio.
Rather than stop the HFT, there is every reason to assume that over the next
few years it could increase by a factor of ten. Will it matter that eventually
99.9999% of all trading will be this sort of manipulation? Nope. There is no
The manipulation and criminality has only just begun. It's funny that you mention
the mafia and protection money. Sooner or later, the criminality will become
as open as the mafia running a protection racket. It happened in Germany in
the 1930s. People will and have learned to turn a blind eye to it.
Even in today's world where it is so easy to capture crime and corruption on
video, it still does not matter. Already we are seeing multiple instances where
blatant crimes are commited right on the camera, with the perp in full view
and fully identified, and yet the victim receives nothing in the way of justice.
The closest to justice he will see is having his video pulled off of youtube!
2009 Jul 24 11:07 AM
Reply -- Report abuse
notsosmart has yet to provide a bio.
its all ponzi/casino.a dumb-dumb like me has been saying it for years.it
will only get worse as ethics,honesty & transparency are mostly gone.even the
so called god fearing religious folks are for the most part untrustworthy.
Optimistic about precious metals, energy, agriculture and China for the next
several years. Pessimistic about financials, commercial real estate, airlines,
Europe and the USA for the next several years. More inclined to hang my
hat with Jim Rogers than with Jim Chanos. Generally more comfortable...
"They intentionally probed the market with tiny orders that were immediately
canceled in a scheme to gain an illegal view into the other side's willingness
to pay." Talk about a f**king license to steal. Not only with the government's
cooperation, but with the government's support and encouragement. And people
say the game isn't loaded. I'm not certain whether I'd rather trade for
Goldman or have an advance copy of tomorrow's lottery numbers. Probably
not much difference in the two. What a crock of sh#t.
2009 Jul 24 10:57 AM
Reply -- Report abuse
Iconoclast421 has yet to provide a bio.
Rather than stop the HFT, there is every reason to assume that over the
next few years it could increase by a factor of ten. Will it matter that
eventually 99.9999% of all trading will be this sort of manipulation? Nope.
There is no law.
The manipulation and criminality has only just begun. It's funny that you
mention the mafia and protection money. Sooner or later, the criminality
will become as open as the mafia running a protection racket. It happened
in Germany in the 1930s. People will and have learned to turn a blind eye
Even in today's world where it is so easy to capture crime and corruption
on video, it still does not matter. Already we are seeing multiple instances
where blatant crimes are commited right on the camera, with the perp in
full view and fully identified, and yet the victim receives nothing in the
way of justice. The closest to justice he will see is having his video pulled
off of youtube!
2009 Jul 24 11:07 AM
Reply -- Report abuse
notsosmart has yet to provide a bio.
its all ponzi/casino.a dumb-dumb like me has been saying it for years.it
will only get worse as ethics,honesty & transparency are mostly gone.even
the so called god fearing religious folks are for the most part untrustworthy.
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October 02, 2017