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Guest Post: Another May 6th Villain – “Hot Potato” Volume
Submitted by Themis Trading
Another May 6th Villain – “Hot Potato” Volume
Speaking at a Washington conference yesterday, CFTC Chairman Gary
Gensler hinted that brokers/institutional traders using algorithms might
have to face new rules regarding size, style, and limits. He, of
course, was alluding to the large E-Mini order on May 6th.
In his estimation the order could not be handled because there weren’t
parties willing to buy the order and hold it for any extended period of
time. He states:
Just as there is a difference in tennis or ping pong between the
rally before the point and the point itself, in markets, there is a
difference between a position going back and forth between market makers
and a position actually being bought by a fundamental buyer who will
hold it overnight. Much of the volume on May 6 was just
positions being moved back and forth over a matter of seconds between
high-frequency traders and other market makers. This is what our economists refer to as “hot potato volume.”
For the large trader’s order to actually be absorbed by the market, it
had to find fundamental or opportunistic buyers who were willing to hold
the position at least for more than a few seconds…The events of May 6
demonstrate that, in volatile markets, high trading volume is not
necessarily a reliable indicator of market liquidity.
Chairman Gensler is acknowledging what we have said repeatedly: volume does not equal liquidity. Our
marketplace has become addicted to “hot potato volume”; in fact, we
have become hostage to it. Consultants, exchange-heads, and conflicted
brokers repeatedly warn, every chance they get, that any wrist slapping,
any regulation, any attempts to limit the profitability of HFT, will
widen spreads and decrease volume! The focus should always have been,
and should be today, on making our markets liquid. High volume is not
the same thing.
Were HFT firms churning and playing “hot potato” to such an extreme
extent, such that they were skewing volume statistics and unnecessarily
(and harmfully) driving up volume? In the May 6th E-mini contract
example, much has been made about the size of the trade. While it may
be true that this was a large trade, shouldn’t the market have been
able to absorb a 9% participation rate? In addition, let us dissect the
75,000 contract E-Mini sell order. Only 35,000 of those contracts were
sold on the way down; the remaining 40,000 were sold in the rebounding
tape. Also, of the 35,000 contracts sold in the down tape, only 18,000
of them were executed aggressively and the remaining 17,000 contracts were executed passively (see footnote 14 on page 16 of the CFTC/SEC report).
Now, let’s be clear, the problem was not the order rather the problem was the “hot potato volume” that the HFT traders generated that spilled over into the equity markets, specifically in ETF’s. The SEC report states: “From
2:41pm to 2:44pm on May 6th, HFT’s traded 140,000 E-Mini contracts or
over 33% of the total trading volume, according to the CFTC/SEC report.” This implies that 424,000 contracts traded in this 4 minute period. This frenetic pace of HFT trading is what caused the algorithm to execute its 9% of volume in 20 minutes.
This “hot potato” volume is also very similar to what is known as “circular trading”.
Circular trading is rampant in India and their regulators have been
grappling with it for years. Circular trades happen when a closely knit
set of market participants, mainly brokers, buy and sell shares
frequently among themselves to effect a security price. These trades do
not represent a change in ownership of the security. They are simply
being passed back and forth to create the illusion of price movement and
volume. “Hot potato” volume is not something that should be just
overlooked as harmless since it is only HFT’s trading with each other.
Their volume drives institutional decisions, albeit less so going
forward, we hope. Most damaging though, is that hot potato volume lulls
everyone into an illusion of healthy markets possessing liquidity, when
in fact the markets have become shelled out and hollow.
Tomorrow, maybe we’ll talk about who benefits from volume.
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Liquidity requires confidence. When the U.S. government controls the economy, as it does, then that necessarily excludes confidence. So, quit wishing for confidence, and for that matter, quit wishing for the U.S. government to stop controlling the economy. Look at the facts for what they are. And what are they? You tell me. But please, eschew the normative. Strongly favor the speculative.
Gary Gensler is generally a tool... I can't believe he actually said the right thing this time.
you mean "Wall Street needs to be hugely profitable and how!" Okay. I'm with ya on that one. Gary Gensler? Of the CFTC? Exactly "what has he done lately"? In fact "has this administration done anything to prevent a single merger"? the silence is deafening is it not? and of course they've done a great job moving a couple of trillion in volume to the bond trading pits which are located in....whoooaaa PRESTO...Chicago! Now we all should wonder "how can these interest rates stay so low"? Here's my answer: I HAVE NO PHUCKING CLUE. For those that scream at higher equities as wrong I would recommend this answer.
Tomorrow, maybe we’ll talk about who benefits from volume.
Preview: Not you!
Well, another flash crash will scare even more peeps out of the market & I think eventually all we'll having is computers trading with computers. Can't imagine that's too profitable ;)
Just an observation: I was trying to BUY the market during the "flash crash". My first market order was at 2:41:10.....that was filled in 1 minute! The next order was at 2:51:44...that was filled 47 minutes later and the last order was at 3:01:55 and that was filled at 7:38pm at the NYSE last sale price. All the orders were executed thru Fidelity. For the entire time DURING the transaction, the trade was PENDING. For the balance of the day, I could not use my Active Trader system. It was frozen. So, what ever anyone SAYS the reason for the was.....it was clear to me that it was a total market disruption. It simply prevented all by a very few from transacting. I have been in this business for over 25 years...one of the most important aspects of "risk managment" is having the sense and the ability to LOWER your risk profile when you want at some price...it was clear that was not the case on May 5th. It is also amazing that only PART of the order was filled on the way down...can you imagine how much faster it would have gone up if that selling was not there!
My market system went down too. Could not get it to work until the Market corrected. So, I guess that instead of not answering the phones the Brokers now turn their systems off so you cannot trade.
... and if they turn their systems off, the bid disappears, the sell book clears. - Ned
HFT has been used to eliminate Traders. With the daily flat-line ping ponging .1 between themselves no one can make Money but the HFT's. They (the HFT Computers) accomplished this goal by every time a stock would go out of the pre programed area the HFT would slowly bring it back and then flatline it again.
So, the HfT has accomplished its goal of getting the Traders out of the Market including Retail Investors. The Market is much easier to control without any one Trading. They can take the Market where ever they want without interference.
2008 Meltdown actually created a Monopoly in the Market when Goldman got rid of their Competitors or anyone that would take the other side of their Trades. Even Professional Traders are getting out of the Market, including Hedge Funds.
So, what do we have? Who knows. It is not a Market as there are no Traders putting their Money in the Market thru trades. Just Liquidity TAKERS, HFT Computers. Where will it end? It is anyones quess.
I think that the most dangerous aspect of the current market structure is the immediate and complete knowledge of the HFT of all market volume. I watched every tic of May 6th.....the market was NOT dramatically different that any other -225 Dow day. I heard that when the suspect WR oda went into the Barc system, the size of the oda dropped it right down into the market in one block...giving the impression of even greater volume.....it was the most dramatic episode of 'front running' that I have ever seen.....even the old 'specialists' used to get 'full' and tired. It simply means that if you plan is to 'get out' on that big down day, you have absolutely no idea what is in store for you.
bobcat, that is a good point - front running. since most hft models use some type of weighted mid value that order caused such a low price bc of the offer size, every hft went offered. SO, why doesn't one of the market making firms being hurt by hft just throw out large bids/offers on names to screw-up the hft's mid value??? Maybe then all stocks will not be 100% correlated and we can get back to some type of stock price (company mkt cap) valuation.
I looked at a comparison of SPY:$UST2Y on stockcharts.com. From 2003-2009, the highest level was 150x or less except for a brief instant in early Dec 2009. The ratio fell all the way to the 200MA before the month was up. However, since mid-June 2010, it hasn't been *below* 150x. Spiked to over 300 in Sept. Currently 277.
To put things in perspective, the ratio during the dot com peak in 2000 was only 20x. As interest rates were lowered, the ratio was about 50x at the bottom. Surged to 75x during the initial rally. But traded at 20-40x for much of 2004-2005. 300x ?? WTF?!? It should be more like 80x or less.
I don't see how stocks aren't at least 20-40% overvalued right now. To get to a historical norm level with a 3% div yield, the S&P500 would have to get down to ~737.
The US$ is getting killed the last 6mon, right? Not compared to the 2yr. Ratio of $USD:$UST2Y has gone from 80x to 191x (peaking at almost 220x) the last 6mon. Since 2003, this is the highest ratio. In fact, in 2007, it was only at 20x. For the dollar to be gaining ground against ANYTHING, that's saying something...
If the gov't keeps killing the dollar to prop up stocks, then eventually the debt load will cause the U.S. to lose it's AAA rating.
It makes good long-term economic sense to raise interest rates. Whatever happens with stocks...happens. If a TBTF bank or 2 goes under along the way, so be it. A dip to 737 would encourage real/legit investments to be made. It may take a decade or 2 before we start to experience organic growth again, but at least it would be valid -- not some HFT computer-enhanced fantasy.
There is a world of difference between saying:
- HFT volume is not genuine liquidity
and
- HFT volume is bad
HFT narrows the bid-ask spread. That is good for anyone who wants to execute a real trade (to hold overnight) and bad for HFT's competitors.
But HFT does not, and cannot, guarantee that there actually *is* a bid in the first place. The market maker (which role HFT seems to be taking) does not provide the bid. The MM narrows the spread. Well, there are times with no bid.
Why?
Hint: people are losing confidence. And piling on ever more rules out of desperation, sorry "regulations" will not restore confidence.
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