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Chicago Federal Reserve Joins Zero Hedge In Warning Over Threats From High Frequency Trading
The key recurring topic on Zero Hedge over the past year has been our ongoing warning over the threats presented by high frequency trading on proper market functioning. A few isolated voices, most notably Delaware senator Kaufman have enjoined this effort and have demanded that the SEC propose a market review in which the role of HFT is closely scrutinized, yet we are fairly confident that absent another major market crash precipitated precisely by the factors that we have been warning against, the SEC will end up doing absolutely nothing, until it is too late. Yet we are gratified that today, none other than the Chicago Federal Reserve has taken up the cause of admonishing about the broad and systematic danger that HFT presents to market topology. In a paper titled "Controlling risk in a lightning-speed trading environment" in which the Chicago Fed says that regulators should examine the risks of HFT which has the potential to amplify systemic risk and errors.
The paper notes:
A handful of high-frequency trading firms accounted for an estimated 70 percent of overall trading volume on U.S. equities markets in 2009. One firm with such a computerized system traded over 2 billion shares in a single day in October 2008, amounting to over 10 percent of U.S. equities trading volume for the day. What are the advantages and disadvantages of this technology-dependent trading environment, and how are its risks controlled?... The high-frequency trading environment has the potential to generate errors and losses at a speed and magnitude far greater than that in a floor or screen-based trading environment.
The paper's author, Carol Clark, asks whether those using HFT are ready to withstand the potential losses due to the lack of any regulatory framework from a risk-to-capital standpoint.
Her conclusion:
The high-frequency trading environment has the potential to generate errors and losses at a speed and magnitude far greater than that in a floor or screen-based trading environment. In addition, the types of risk-management tools employed by broker–dealers and FCMs, their customers, nonclearing members, exchanges, and clearinghouses vary; and their robustness for withstanding losses from high-frequency algorithmic trading is uncertain. Because these losses have the capability of impacting the financial conditions of the broker–dealers and FCMs and possibly the clearinghouses, determining and applying the appropriate balance of financial and operational controls is crucial. Moreover, issues related to risk management of these technology-dependent trading systems are numerous and complex and cannot be addressed in isolation within domestic financial markets. For example, placing limits on high-frequency algorithmic trading or restricting unfiltered sponsored access and co-location within one jurisdiction might only drive trading firms to another jurisdiction where controls are less stringent.
We are confident that as ever more "relevant" market participants realize the persistent threat posed by HFT, the risk parameters that HFT participants, many of which are merely a group of math Ph.D.'s with a collocated station and a few algorithms, will be substantially reinforced. This will inevitably mean the elimination of a vast number of marginal players who will be unable to ensure their capital adequacy in proposed draconian-downside scenarios (which ironically would merely be reinforced by the very algorithms that have ridden the market ever higher since the March bear market squeeze began).
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Sure, now they are worried when HFT might accelerate a downside move. They weren't too worried when it was creating a bubble.
what risk? do overs are included with all "unfiltered sponsored access and co-location"
But without HFT there would be no liquidity in the market. CNBC told me
In fact I wonder how markets even existed before HAL was born? We were a backwards people.
I hope Goldman can stop this rogue operation out of Chicago.
> We were a backwards people
Not backwards - just screwed by human market makers colluding to produce spreads of 1/8th of a dollar.
just wait til those of us who aren't predatory flash algo assholes get our sniping posts cut down ... there will no one and nothing left to keep mkt makers & the PPT in check. and once 'we're' removed from our posts, 'you' (retail) will have no one and nothing watching over the forest; we'll all be confined to the trees.
i know it sucks that current iterations of HFT 'hurt' 'you' but the bottom line (much like outlawing short selling, not naked reg sho bullshit, but 'normal' shorts) is that this is going to be one of the most pyrrhic victories that retail / congress will ever 'win.'
gonna feel great about your victory until we break 8200 DJ and then someone starts saying 'hey, was that HFT undergirding so terrible .'
you don't want 'us' up in our posts scoping you down during the day but there is simply no alternative that doesn't amount to a full-blown crash in equity markets.
you don't have to like what i'm saying and you certainly don't have to agree w/ my personal opinion ... that said, i'm telling you point f'ing blank that when HFT writ large is grossly classified n 'outlawed' that equity markets will be crashing and that it will fjuck 401(k)'s. mark that.
"One more such victory, and we are lost."
For the record, I think you're spot on. Eliminating one of the few sources of pseudo-independent market liquidity in this environment will have consequences that the crowd-pleasers in Congress might not find so palatable.
The possibility of an error (human, hardware or software) generating a massive market moving series of transactions is real - however the threat exists with or without HFT, since any broker dealer could cause the error (i.e. a bug at E*Trade could just as easily cause them to loop a retail market order ad infinitum as a bug at GETCO).
The only solution is to mandate that exchanges implement controls... since those are the only controls that could possibly be audited.
The notion that broker-dealers must all create their own controls, and that HFT must either apply to become broker-dealers or move their trading to broker dealers does next to nothing in resolving the risk - a risk that has existed for decades.
Agreed, erroneous trade controls at the exchange level, inside the exchange, are pretty much the only way to prevent the HFT meltdown the article worries about.
Broker controls are nice, but brokers are badly policed and badly conflicted.
But exchanges -- hey there's only like 13 of them, and only 5 big ones, so there's a real chance to get it right.
It's about time! Bitches don't get it.
HFT BAD, LFT(LowFrequencyTrade) GOOD.
ZH is eGOD. Sent to us from our friends at FOX. The only website that tells the truth.
Zero Hedge; empowering the people with the knowledge to make super educated (successful?) trades.
someone please get your hands on jan/feb issue of advanced trading...
I mentioned this over on another forum, but might as well put it out there. The mere fact that they are putting this story out there, gives the GOVERNMENT the right to not open or halt markets intra-day, for the Good of America. Now that they labeled this a potential THREAT, they can stop falls and shut things down and just blame it on computer driven trading. They can wait for any unspecified time before they open the markets by claiming they are waiting for a balanced open. This is utter bullshit. They never chose to stop the RAMP UP ON ZERO VOLUME, why should they stop the waterfall that inevitably WILL OCCUR when the turn the machines off. Time to regulate the regulators...... using boiled rope and lamp posts.
Interesting thoughts. Thank you.
It does not matter clown man. Limit down is only a reflection of intense sort term emotions.
A market can drift downward for months without hitting limits as it falls.
I will wait to see the reported unemployment numbers.
It's not the 'reported' numbers that worry me.
Just like 'sub-prime is well contained', they will do absolutely nothing about it until it has completely fallen apart... again.
I am sure HFT has necessary risk controls in place to ensure the counterparty has enough credit to trade before it's too late. Just wonder what would happen when 1 of those 10 billion trades are rouge and it's a large amount ? HFT operators are sleeping over a bed of t n t.
Trader at our firm entered wrong symbol on TSX, sold 450,000 shares @ 10.50 instead of the .40 on TSXV, on a stock that trades 500 shares a day, no market survelliance, no filters, over 25% of the outstanding! TSX refused to bust the trade, he is now out of work.
Thank God computer trading is without human error.
Dude you'e getting a DELL.
That should make you shiver.
Why do so many of you think HFT's are good for the market? It was the Quants that lost control of the market and helped take it down to the lows in 08. Could todays drop be the beginning of another screwup by the Quants. Who's going to bail out Goldman Sachs and their ilk the next time they screw up? I don't see any hands raised.
Guys,
You really don't get it. You can rail all you want, but how do you stop it? As long as there is electronic data and smart folks that can program, trading will forever forward be electronic. Now you can implement a transaction tax (which will just widen spreads and soak the investor), or speed bumps, but that doesn't stop the issue that the early bird catches the worm, and that at whatever spread you decide to have (pennies, teenies, or friggen dollars) the first one to see the quote change and react will get the limit order. do you really want to go back to specialists and market makers controlling the book? The best you are going to get is pre-trade risk checking. Unless you repeal Moore's Law and Medcalf's law, the guys with the fasted computers and fastest bandwidth will win. Computers will be the ones trading - not humans and the fastest guy to the quote will get it. Unless you ban the bid/offer market and go to a completely dark point in time cross. Now that doesn't mean this is bad for investors. As long as your time horizon is longer than a few seconds - all of this really means nothing. In fact all of this high frequency trading is actually good for you because the more competition there is to be at the top of the book the more efficient the market is and the easier it is for the investor (large and small) to get done. The biggest problem would be a)an algo gone wild or b) that there was only one HFT in which case there wouldn't be any competition to be at the top of the book and the single HFT could really influence the market. With market making and HFT - the more the merrier.
HFT is good for liquidity, markets, etc.
Either it helps push rationality and moderate volatility (this is good for average investors, passives).
Or it does the opposite, exacerbates swings and volatility (this is good for smart speculators, smart and careful).
Which one is it?
-BBH
we can whine all we want but hft isnt going away. re the TSX trade in #217746: did they fire the CIO for not implementing simple checks to avoid stupid mistakes? did they fire the CEO for not thinking abt same? did the board fire its tech oversight committee for negligence, or if there was no tech oversight committee, did the chairman resign for not reading the news and knowing that there is risk out there to mitigate? people will always make mistakes. the people who are really responsible are the ones who ignore the widely known risks and dont realize they should be managing them
hmmm....the federal reserve is saying that HFT is a problem. isn't that pot calling the kettle black? HFT actually provides something useful to the markets - aggressive competition in short term trading. the fed just provides inflation.
i'm surprised zero hedge is not calling the fed out on that.