A year ago, before anyone aside from a hundred or so people had ever heard the words High Frequency Trading, Flash orders, Predatory algorithms, Sigma X, Sonar, Market topology, Liquidity providers, Supplementary Liquidity Providers, and many variations on these, Zero Hedge embarked upon a path to warn and hopefully prevent a full-blown market meltdown. On April 10, 2009, in a piece titled "The Incredibly Shrinking Market Liquidity, Or The Black Swan Of Black Swans" we cautioned "what happens in a world where the very core of the capital markets
system is gradually deleveraging to a point where maintaining a liquid
and orderly market becomes impossible: large swings on low volume,
massive bid-offer spreads, huge trading costs, inability to clear and
numerous failed trades. When the quant deleveraging finally catches up
with the market, the consequences will likely be unprecedented, with
dramatic dislocations leading the market both higher and lower on
record volatility." Today, after over a year of seemingly ceaseless heckling and jeering by numerous self-proclaimed experts and industry lobbyists, we are vindicated. We enjoy being heckled - we got a lot of it when we started discussing Goldman Sachs in early 2009. Look where that ended. Today, we have reached an apex in our quest to prevent the HFT "Black Monday" juggernaut, as absent the last minute intervention of still unknown powers, the market, for all intents and purposes, broke. Liquidity disappeared. What happened today was no fat finger, it was no panic selling by one major account: it was simply the impact of everyone in the HFT community going from port to starboard on the boat, at precisely the same time. And in doing so, these very actors, who in over a year have been complaining they are unfairly targeted because all they do is "provide liquidity", did anything but what they claim is their sworn duty. In fact, as Dennis Dick shows (see below) they were aggressive takers of liquidity at the peak of the meltdown, exacerbating the Dow drop as it slid 1000 points intraday. It is time for the SEC to do its job and not only ban flash trading as it said it would almost a year ago, but get rid of all the predatory aspects of high frequency trading, which are pretty much all of them. In 20 minutes the market showed that it is as broken as it was at the nadir of the market crash. Through its inactivity to investigate the market structure, the SEC has made things a million times worse, as HFT-trading seminars for idiots are now rampant. HFT killed over 12 months of hard fought propaganda by the likes of CNBC which has valiantly tried to restore faith in our broken capital markets. They have now failed in that task too. After today investors will have little if any faith left in the US stocks, assuming they had any to begin with. We need to purge the equity market structure of all liquidity-taking parasitic players. We must start today with High Frequency Trading.
Further to demonstrate this point, we bring our readers attention to our post from April 1, 2009 titled An Open Letter To Quant Funds. In it we said:
In his April 14th report Matt Rothman wrote about a dramatic,
parabolic outperformance trend for names with high short interest, low
prices and fundamentally weak names. He opined that all conditions for
this trend to end are in place. Contrary to his very valid arguments,
the trend accelerated yesterday.
Stocks with poor fundamentals,
market share losses and poor earning prospects that quantitative
managers tend to short, gained more than higher quality long positions.
is clear from Mr. Rothman's report that this trend is a main
contributor to outsized losses for quant managers. Some of his
respondents admitted to hitting P&L stops. Recent
acceleration of this trend, aka the "crap rally" clearly further
damaged quantitative managers performance and resulted in further hits
of P&L stops. The resulting short covering and long index hedges
have perpetuated the market rally for now.
At this point, it is hard to say what set off this process, but it is currently accelerating and feeding on itself.
the timing of Mr. Rothman's poll of quant managers, it is clear that
smaller managers had ample time to exit positions and get flat.
Continuation of the "crap rally" could indicate larger, systematic problems at the largest, most sophisticated quant managers.
are paging Jim Simmons, DE Shaw, Citadel, LSV, Jacobs Levy and
"significant"' others. Are you all right? We need you alive, small and
nimble, to help provide liquidity and maintain orderly markets, not outsized, bigger than the market and dead.
If you still can, please come out and speak up before it is too late.
Today, it was too late. Liquidity disappeared.
And now we have to deal with the consequences. One amateurish way is to cancel trades which is what the Nasdaq is doing. This is simply pathetic, and indicates that everyone is powerless to stand before the consolidated idiocy of the HFT "cash cows."
One person who does get it is Senator Kaufman, who should be a shining example to all the other idiots and traitors in both Congress and Senate. Senator Kaufman issued the following release:
“As I said on the Senate floor today, the growing sovereign debt and banking crisis in Europe is very troubling. The U.S. needs to get its financial house in order through strong Wall Street reforms that will serve as a lasting bulwark against financial instability.
“I also have been warning for months that our regulators need to better understand high frequency trading, which appears to have played a role today when the US market dropped 481 points in 6 minutes and recovered 502 points just 10 minutes later. The potential for giant high-speed computers to generate false trades and create market chaos reared its head again today. The battle of the algorithms – not understood by nor even remotely transparent to the Securitiesand Exchange Commission – simply must be carefully reviewed and placed within a meaningful regulatory framework soon.”
It is time fot the SEC to step up to its own sole duty, which is not to guarantee itself jobs at Goldman Sachs (well, not so much anymore), or to watch 18 hours of transvestite porn each day, but to protect the US investor from such borderline criminal activity as High Frequency Trading gone amok. Forget the Fat Finger - today we were one Fed Finger away from a meltdown that would make Black Monday seem a joke in comparison. Next time we won't be so lucky.
We will have much more to say on this shortly, but we leave you with the words of Dennis Dick of Bright Trading:
Predatory Market Making May Have Led to Crash
Dennis Dick, CFA
Bright Trading LLC
On January 4th of this year, Rambus (RMBS) fell 30% in a matter of five minutes. It immediately bounced back and was later attributed to a trader with a “fat finger”. When this incident occurred, I discussed on Zero Hedge, the possibility of this being more than just a trader with a “fat finger”. (http://www.zerohedge.com/article/rambus-hft-fat-finger-precursor-things-...). I speculated that this could have been caused by a market structural problem. This could have been caused by a lack of liquidity due to predatory market making.
Today the same incident occurred, except this time, it happened in the overall market. Again, the media is blaming a trader with a fat finger. This may have been the catalyst but it was not the problem.
Predatory market making practices are driving liquidity providers out of the market. Algorithmic systems constantly step in front of displayed liquidity providers, and discourage them from placing passive limit orders. They are programmed to automatically step in front of displayed limit orders, to be at the front of the line for execution. This practice is especially prevalent in thinner stocks. If a human trader places an order at $20.05, the algorithmic system automatically bids $20.06. If the human raises their bid to $20.07, the computer goes to $20.08. This discourages true liquidity providers, and they place less passive limit orders.
Even in the 5 minutes that the market was crashing, these algorithmic systems were still abusing displayed orders. I placed a few buy orders during the crash, and my orders were still automatically stepped in front of by a penny. As my friend, Jason Fournier mentioned in his comments to the SEC, “not only are they discouraging liquidity, they are not allowing it.”
Broker-dealer internalization also abuses displayed liquidity as they continuously internalize retail order flow in front of displayed limit orders. In some cases they step in front of the order by as little as 1/100th of a penny, an abusive practice called sub-pennying.
Broker-dealers justify this practice by saying they were giving their customer price improvement. But they completely ignore the unquantifiable loss to the market participant who was displaying the order, and did not receive the fill.
These predatory market making practices are having a devastating effect on liquidity in our market. As true liquidity providers become more discouraged, and place less passive limit orders, the depth of the market gets thinner. Therefore, when we have a trader with a “fat finger” accidentally make a mistake, there are less liquidity providers to cushion the blow.
If these predatory market making practices are allowed to continue, eventually there will be no real liquidity in the depths of the market, and when there is a market impact event, we’re in big trouble.
Today was just a taste of things to come, if our regulators don’t take note.
And for the benefit of the SEC, this is what a broken market looks like.