Tag Archives: HFT

Regulations May Increase Risk of Flash Crash, Traders Says

A political drive to impose new regulations and rules at stock exchanges at a breakneck pace in the aftermath of another incident similar to the “flash crash” could actually increase risks in the financial system, according to hedge fund managers. They also claim that the politicians have no idea of how the financial markets work.

“What is new is technology. We need to understand it and we have to work with it.”

Michael Levas

“With a rush to bring new rules, you bring more layers of complexity, which in turn creates more risks. I would be very scared of a rush to add more layers of complexity to the markets because all they are doing is increasing the risk of something bad happening again,” says hedge fund manager Nick Nielsen at Deutsche Marshall Wace in London.

“I am a bit scared to see what the public response would be if that did happen again. There could be some pretty aggressive regulation coming very quickly, similar to what happened when all of the bank stocks were getting hammered in 2008,” Nielsen says.

Fractions of a Cent, Millions of Times

In Nielsen’s opinion is the current form of high-frequency trading (HFT“essentially a casino.”

“They make a lot of bets and they lose a lot of bets. But they happen to win more than they lose,” he says.

Peter Nabicht, chief technology officer at Allston Trading, a Chicago-based trading firm, also agreed that the casino analogy had some validity.

“Casinos make very small amounts on each bet and HFT firms do the same thing,” he says.

At the moment HFT accounts for 54 percent of equity trading in the US and 34 percent of equity trading in Europe, according to Tabb Group, a US-based financial technology consultancy firm.

Politicians Have “No Idea” About Trading

Nabicht and Nielsen agreed that the increasing grip HFT has on the financial markets formed part of an evolution of the financial markets towards increasingly electronic and automated trading strategies.

Michael Levas, founder and chief investment officer at Olympian Capital Management, a proprietary trading firm based in Florida, called for regulators and market participants to embrace the new trading technology shaping the trajectory of the financial markets.

”What is happening in the market place is nothing new,” he says.

“What is new is technology. We need to understand it and we have to work with it. That is the only way that we are going to be able to fix all the inconsistencies which are prevalent in the market place.”

Levas attacked politicians in Europe such as French Finance Minister Christine Lagarde for having “no idea” what it is like to work in the financial markets.

On that particular issue, I belive the hedge fund managers are right.

Read the full post at; ultrahighfrequencytrading.com

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The Rise Of The New Market Makers

Should certain algorithmic trading strategies be banned? The question have been raised after the so-called “flash crash” in the U.S. stock market on May 6.  Two strategies in particular – momentum ignition and order anticipation – were explicitly mentioned as potentially destabilizing forces in the SEC’s January Concept Release on Equity Market Structure. Professor Rajiv Sethi at Columbia University, however, don’t think it’s a good idea.

“If too great a proportion of total volume is driven by strategies that try to extract information from market data, the data itself becomes less informative over time and severe disruptions can arise.”

Rajiv Sethi

In an earlier post I noted that according to the SEC’s preliminary report on the flash crash of May 6, the vast majority of executions against stub quotes of five cents or less were short sales. This, together with the fact that there was also significant “aberrant behavior” on the upside (with Sotheby’s trading for almost a hundred thousand dollars a share, for instance) led me to believe that most of this activity was caused by algorithmic trading strategies placing directional bets based on rapid responses to incoming market data.

Two strategies in particular — momentum ignition and order anticipation — were explicitly mentioned as potentially destabilizing forces in the SEC’s January Concept Release on Equity Market Structure.

The SEC invited comments on the release, and dozens of these have been posted to date.

There is one in particular, submitted by R.T. Leuchtkafer about three weeks before the crash, that I think is especially informative and analytically compelling. (h/t Dr. Duru).

Leuchtkafer traces the history of recent changes in market microstructure and examines the resulting implications for the timing of liquidity demand and supply.

The comment is worth reading in full, but here are a few highlights. First, a brief history of the rise of the new market makers:

The last 15 years have seen a radical transformation of the equities markets from highly concentrated, semi-automated and intermediate marketplaces to highly distributed, fully automated and nominally disintermediated marketplaces. Along with or because of these changes, we have seen the rise of new classes of very profitable, aggressive, and technologically savvy participants previously unknown in the U.S. markets.

When markets are in equilibrium these new participants increase available liquidity and tighten spreads. When markets face liquidity demands these new participants increase spreads and price volatility and savage investor confidence.

These participants can be more destructive to the interests of long-term investors than most have yet imagined…

What is legal in today’s market includes an exchange that sells real-time data to high frequency trading (“HFT”) firms telling those firms exactly where hidden interest rests and in what direction.

What is legal is the replacement of formal and regulated intermediaries with informal and unregulated intermediaries.

What is legal is the proliferation of high-speed predatory momentum and order anticipation algorithms unrestrained by the anti-manipulation provisions of the Exchange Act.

What is legal is a market structure that dismantled the investing public’s order priorities and gave priority to speed and speed alone and then began charging for speed.

What is legal is the widespread lack of supervision of the most aggressive and profitable groups of traders in American history. What is legal is exactly what the Release says it is worried about, “a substantial transfer of wealth from the individuals represented by institutional investors to proprietary firms…” A HFT market making firm does not need to register as a market maker on any exchange.

To the regulatory world it can present itself as just another retail customer and make markets with no more oversight than any other retail customer… Some HFT firms do register as market makers. By doing so they get access to more capital through higher leverage, they might get certain trading priority preferences depending on the market center, and they get certain regulatory preferences. They are usually required to post active quotes but quote quality is up to the market center itself to specify and some market centers have de minimis standards… Formal and informal market makers in the equities markets today have few or none of the responsibilities of the old dealers. That was the trade-off as markets transformed themselves during the last decade.

In exchange for losing control of the order book and giving up a first look at customer order flow, firms shed responsibility for price continuity, quote size, meaningful quote continuity or quote depth. The result is that firms are free to trade as aggressively or passively as they like or to disappear from the market altogether.

The main problem, as Leuchtkafer sees it, is access to data feeds that make it possible to predict and profit from short term price movements if the information is processed and responded to with sufficient speed:

A classic short-term trading strategy is to sniff out an elephant and trade ahead of it. That is front-running if you are a fiduciary to the elephant but just good trading if you are not, or so we suppose.

Nasdaq sells a proprietary data feed called TotalView-ITCH that specifies exactly where hidden interest lies and whether it is buying or selling interest… Market making, statistical arbitrage, order anticipation, momentum and other kinds of HFT firms are an obvious customer base for this product… The complete details of limit order books can be used to predict short term stock price movements.

An order book feed like TotalView-ITCH gives you much more information than just price and size such as you get with the consolidated quote. You get order and trade counts and order arrival rates, individual order volumes, and cancellation and replacement activity. You build models to predict whether individual orders contain hidden size.

You reverse engineer the precise behavior and outputs of market center matching engines by submitting your own orders, and you vary order type and pore over the details you get back. If you take in order books from several market centers, you compare activity among them and build models around consolidated order book flows. With all of this raw and computed data and the capital to invest in technology, you can predict short term price movements very well, much better and faster than dealers could 10 years ago.

Order book data feeds like TotalView-ITCH are the life’s blood of the HFT industry because of it and the information advantages of the old dealer market structure are for sale to anyone.

But this raises a puzzling question: if the information advantages are truly “for sale to anyone” then free entry should drive down profitability until the return on investment is comparable to other uses of capital. In fact, entry has been substantial:

“In 2000 as the HFT revolution started, dealer participation rates at the NYSE were approximately 25%. In 2008, the year NYSE specialists phased out, HFT participation rates in the equity markets overall were over 60%.”

How, then, can one explain the fact that by Leuchtkafer’s own estimates, “HFT market making was 10 to 20 times more profitable in 2008 than traditional dealer firms were in 2000, before the HFT revolution?”

One intriguing possibility that Leuchtkafer does not consider is that entry generates increasing tail risk, so while ex ante expected profitability is reduced, this does not show up as declining realized profitability until a major market event (such as the flash crash) materializes.

If this interpretation is correct, then some HFT firms must have made significant losses on May 6 that were reversed upon cancellation of trades.

This implicit subsidy encourages excessive entry of destabilizing strategies. The standard argument against increased regulation of the new market makers is that it would interfere with their ability to supply liquidity.

Leuchtkafer argues, instead, that the strategies used by these firms cause them to demand liquidity at precisely those moments when liquidity is shortest supply:

HFT firms claim they add liquidity and they do when it suits them… At any moment when they are in the market with non-marketable orders by definition they add liquidity. When they spot opportunities or need to re-balance, they remove liquidity by pulling their quotes and fire off marketable orders and become liquidity demanders.

With no restraint on their behavior they have a significant effect on prices and volatility. For the vast majority of firms whose models require them to be flat on the day their day-to-day contribution to liquidity is nothing because they buy as much as they sell. They add liquidity from moment to moment but only when they want to, and they cartwheel from being liquidity suppliers to liquidity demanders as their models re-balance.

This sometimes rapid re-balancing sent volatility to unprecedented highs during the financial crisis and contributed to the chaos of the last two years.

By definition this kind of trading causes volatility when markets are under stress.

Imagine a stock under stress from sellers such was the case in the fall of 2008. There is a sell imbalance unfolding over some period of time. Any HFT market making firm is being hit repeatedly and ends up long the stock and wants to readjust its position. The firm times its entrance into the market as an aggressive seller and then cancels its bid and starts selling its inventory, exacerbating the stock’s decline. Unrestrained by affirmative responsibilities, the firm adjusts its risk model to re-balance as often as it wants and can easily dump its inventory into an already declining market.

A HFT market making firm can easily demand as much or more liquidity throughout the day than it supplies. Crucially, its liquidity supply is generally spread over time during the trading day but its liquidity demands are highly concentrated to when its risk models tell it to rebalance.

Unfortunately regulators do not know what these risk models are. So in exchange for the short-term liquidity HFT firms provide, and provide only when they are in equilibrium (however they define it), the public pays the price of the volatility they create and the illiquidity they cause while they re-balance.

For these firms to say they add liquidity and beg to be left alone because of the good they do is chutzpah… The HFT firms insist they add liquidity and narrow effective spreads and they do at many instants in time during the day. They also take liquidity and widen realized spreads as they re-balance in narrow time slices and in the aggregate they can easily be as disruptive as supportive.

Paul Kedrosky made the same point immediately following the flash crash, and it is also mentioned in the SEC report.

As part of the solution, Leuchtkafer proposes that certain trading strategies be prohibited outright:

The SEC should define both “momentum ignition” and “order anticipation” strategies as manipulation since they are both manipulative under any plain meaning of the Exchange Act. These strategies identify and take advantage of natural interest for a trader’s own profit or stimulate artificial professional interest, also for the trader’s own profit. They do so by bidding in front of (raising the price) or offering in front of (depressing the price) slower participants they believe are already in the market or that they can induce into the market. They both depend on causing short term price volatility either to prey on lagging natural interest or on induced professional interest. Any reasonable definition of “manipulation” in the equity markets should explicitly ban them by name.

Rajiv Sethi

Rajiv Sethi

I don’t have any quarrel with this analysis and recommendation, but it’s also useful to look at the problem from a somewhat broader perspective. Generally speaking, stability in financial markets depends on the extent to which trading is based on fundamental information about the securities that are changing hands.

If too great a proportion of total volume is driven by strategies that try to extract information from market data, the data itself becomes less informative over time and severe disruptions can arise.

Banning specific classes of algorithms is unlikely to provide a lasting solution to the problem unless the advantage is shifted decisively and persistently in favor of strategies that feed information to the market instead of extracting it from technical data.

by Rajiv Sethi

Professor of Economics, Barnard College, Columbia University & External Professor, Santa Fe Institute.

Related by the Swapper:

May 6. 2010: “The Black Thursday”

Wall Street Collapse: Did Somebody See It Coming?

U.S. Stock Crash Compels Further Investigation of Wall Street Scam

Welcome Back to Earth, Mr. Market

Living In A Derivative World

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U.S. Stock Crash Compels Further Investigation of Wall Street Scam

Yesterday’s slide in the US stock markets provided further proof that the world’s financial markets are nothing more than a rigged casino where the house  – Wall Street – holds by far the better odds in every game; currency markets, stock markets, derivative markets, commodity markets, than it offers the mark, the retail investors, J.S.Kim writes in a commentary.

“Wall Street’s use of predatory algorithmic High Frequency Trading programs that are designed to trigger cascade-like buying and selling.”

J.S. Kim

“How else could the US DJIA lose 700 points in a 10-minute span and a number of blue chip stocks lose 25%, or 30% in a matter of minutes as well? The answer? Wall Street’s use of predatory algorithmic High Frequency Trading (HFT) programs that are designed to trigger cascade-like buying and selling,” the founder of research company SmartKnowledgeU writes.

“To believe that, as an individual investor, you have a snowball’s chance in hell of beating these Wall Street trading programs that front run your trades or block your trade executions faster than you can blink your eye is tantamount to believing that skill is involved in winning when you shimmy up to the slot machine stool at the Bellagio in Vegas,” J.S. Kim points out.

J.S. Kim is the founder of SmartKnowledgeU™ and the MoneyPing™ investment strategies.

Here’s a short resume of his life and career, so far:

•Invented the first new investment strategies in over half-a-century that do not rely on fundamental or technical analysis as primary screens to select stocks but instead utilize the strength of corporate-government-banking relationships to predict share price appreciation.

• Earned a degree in Neurobiology from the University of Pennsylvania, an Ivy League school perennially ranked with Yale and Harvard as one of the best universities in the world.

• Earned two master degrees (a Master in Public Policy and a Master in Business Administration) from top U.S. graduate programs at the University of Texas at Austin.

• Earned a black belt in aiki-jutsu with special weapons skills under the tutelage of a U.S. Navy SEAL that possessed guerilla and jungle warfare training, as well as trained in Mansekan Aikido, Seidokan Aikido, Chin-na, and Northern Shaolim Gung Fu.

• Managed money for some of the richest people in the world at Fortune 500 companies and Wall Street firms in Los Angeles, Beverly Hills, and San Francisco;

• Delivered healthcare to some of the poorest Americans at a community healthcare corporation in Philadelphia; and

• Lived and worked in Asia and the United States as well as traveled throughout 8 different countries in Asia and numerous different cities throughout Mexico, Canada, and the U.S.

Mr. Kim’s analysis and commentaries are frequently quoted by Reuters, The Wall Street Journal and The Financial Times, among others.

Here is his reaction to what happened on Wall Street last night:

Predatory algorithmic HFT programs aren’t called “predatory” without good reason. Not that yesterday’s sell-off wasn’t partially the result of fear injected into a Fed Reserve inflated stock market bubble, because it was. But Wall Street deployed HFT programs had a lot to do with the cascading nature of the decline in yesterday’s trading.

Continuing our casino analogy, HFT programs act in the same capacity as the thugs employed by casinos that take you to the back room to rain down their “thuggery” upon you if you start winning too much. HFT programs are designed to block the retail investor from making successful trades against the trades of the house (Wall Street) and often prevent the retail investor from obtaining fair prices in the execution of trades in numerous financial markets.

Consider the following example. Stock A’s bid is $10.10 and the ask is $10.13. An investor places an order to buy at $10.13.

Instead of his order being filled and executed as it would if human traders were executing the trade, HFT programs often immediately step up the ask price to $10.14 and screw both parties in the trade. Depending on the orders that HFT programs “see”, sometimes the HFT will see an order at $10.13, and step up the price to $10.18 so the bids follow higher and the bid price gets reset at $10.13 almost immediately.

Or, if the bid price does not follow higher, then the bid-ask spread becomes grotesquely distorted from $0.03 to $0.08 for no other reason than HFT programs are blocking liquidity. Should the human trader withdraw his order to buy at $10.13, then often the bid-ask spread almost immediately returns to $0.03 and the ask will subsequently fall from $10.18 back to $10.13. Should he place the order again seconds later, however, the bid-ask spread will often immediately increase again with the bid price increasing to a point higher than $10.13 again.

The HFT programs execute the shame shenanigans in the options markets depending on what side of the market they are manipulating.

I have many times been forced to take a lower profit on options trades because of HFT programs.

For example, if I placed an order to sell on option contracts at $2.50 when the bid is at $2.50 and the ask is $2.60, instead of my order filling, the bid often immediately falls to $2.40 and the ask becomes $2.50, blocking my order from filling. HFT programs run amok in options markets as well.

This is Skynet from Terminator rigging markets, destroying liquidity and unfairly rigging prices of all possible financial instruments that trade in every conceivable market, all with the blessings of the SEC.

Wall Street has been running these types of scams ever since advances in technology have enabled them to develop algorithmic programs to manipulate markets.

In fact, on my company’s website, I have stated the following message for a long time now: “Today, when stock markets rise in the face of horrid economic fundamentals, fundamental and technical analysis are inadequate when making critical decisions about your financial future…If one expects to be profitable in today’s investment world, one MUST realize that ALL MARKETS ARE RIGGED, including gold, silver, currency and stock markets…Without understanding the fraud and rigging games of the financial oligarchs, it is impossible to accurately predict long-term trends.

It is a near certainty that future shocks to the economic system will catch the vast majority of all investors unprepared and we expect great shocks to hit the global economy at some point in 2010.”

The only difference is that when I started pushing this message a decade ago, people laughed off my proclamations and accused me of being enamored with conspiracy theories.

Today, more and more people finally are awakening to the reality that such a message is not a conspiracy but a fact.

So this is how the Wall Street Casino Scam operates.

The ratings agencies like Moodys and Standard and Poors are the pretty cocktail waitresses that lure the mark (the retail investor) into the Casino (stock markets) with free alcoholic drinks (abominably horrible and deceitful credit ratings of financial instruments) to instill the mark with the false sense of confidence necessary to induce gambling in the rigged Casino.

The regulators like the CFTC and the SEC are the pit bosses that oversee the floormen (Wall Street firm CEOs) that oversee the table games dealers (the firm’s traders) and ensure the games (stock markets, currency markets, commodity markets) you are allowed to play possess a feature (HFT trading programs) that ensures that the odds will always enormously be in favor of the house.

The pit boss oversees all floor dealers and conspire with the regulators (the cocktail waitresses) to give gamblers (the investor) a sense that all dealings are legitimate even though the odds of every table game (currency markets, commodity markets, stock markets) are insanely rigged in favor of the house (Wall Street firms).

If we consider the table game of blackjack, in a real casino, should you receive a good hand, the dealer will pay out your bet. In the case of Wall Street, due to HFT programs, in many instances, should an investor receive a favorable hand (i.e., a favorable move in the stock market) in the game he or she is playing, HFT programs move in to prevent the bet from paying out in full or paying out at all (an investor’s sell order never executes at the price at which the market has informed the investor that he or she can cash out).

In essence, financial markets are rigged exactly like casinos except for one difference. The predatory algorithms executed by HFT programs ensure the winnings of the house to a much greater extent than any Casino table game is able to accomplish.

It this sense, Wall Street is rigged to a greater extent than even casinos. In the instances when you win, they deploy HFT trading programs that prevent the bet from paying out full value so that the house (Wall Street firms) can step in and earn profits from a trade it spots AFTER an order has already been placed.

Or in the mirror example, HFT programs allow the house (Wall Street firms) to step in front of trades they “see” and front run them for their own profits, again screwing the retail investor out of a lower price in a buy transaction. In these cases, which must happen by the thousands every day, the HFT programs employed by Wall Street screw both the buyer and seller in the transaction as it always attempts to widen the losses or lessen the gains of both parties involved.

In some instances, frustrated traders leave the game tables so liquidity dries up which leads to the establishment of even more grossly distorted and unfair bid and ask prices. Despite this practice being commonplace, the pit bosses of the giant rigged Wall Street casino, men like Goldman Sachs’s Lloyd Blankfein, want us to believe that their enormous profits are derived because of their upstanding integrity and above-average intelligence of his firm’s employees.


Next on the list of financial weapons of mass destruction?

The $600 trillion (notional value) of the derivatives market. Oh, what joy we’ll experience when the banksters are eventually forced to unwind a fraction of this market and various parties will actually be forced to make good on these contracts when the financial instruments insured by them start heading south (or the true value of them are finally recognized, whichever comes first).

It’s no wonder that the price of gold has diverged from the behavior of the US dollar and US stock markets on multiple days for the last several weeks.

The next significant dip in gold/silver price that occurs may be the last best buying opportunity in “real” money for years.

By J.S. Kim

Related by the Econotwist:

May 6. 2010: “The Black Thursday”

Bail Out Pyramid?

“We Stand At The Brink Of The Next Great Crisis”

Living In A Derivative World

When Will God Destroy Our Money?

The Great Golden Lie

Organizing Financial Rebellion

Are Governments Producing Conspiracy Theories?


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