How HFT Quote Stuffing Caused The Market Crash Of May 6, And Threatens To Destroy The Entire Market At Any Moment

Tyler Durden's picture

Even as the idiots at the SEC mope about cluelessly, confirming they deserve not one cent of taxpayer money to fund their massively overbloated budget, and should all be summarily fired to collect tarballs in the Gulf of Mexico (and soon Maine), our friends at Nanex have conducted an exhaustive analysis (must read for everybody concerned about market structure), in which they identify the various parties responsible for the market crash, and, drumroll please, High Frequency Trading stands at the pinnacle of culprits for the 1,000 point Dow drop. From their findings: "While analyzing HFT (High Frequency Trading) quote counts, we were shocked to find cases where one exchange was sending an extremely high number of quotes for one stock in a single second: as high as 5,000 quotes in 1 second! During May 6, there were hundreds of times that a single stock had over 1,000 quotes from one exchange in a single second. Even more disturbing, there doesn't seem to be any economic justification for this. In many of the cases, the bid/offer is well outside the National Best Bid/Offer (NBBO). We decided to analyze a handful of these cases in detail and graphed the sequential bid/offers to better understand them. What we discovered was a manipulative device with destabilizing effect." In other words: enough with all the bullshit about HFT as a liquidity provider mechanism: in reality this is just a facade for the most insidious, computerized market manipulative device ever created. Nanex' conclusion: "What benefit could there be to whomever is generating these extremely high quote rates? After thoughtful analysis, we can only think of one. Competition between HFT systems today has reached the point where microseconds matter. Any edge one has to process information faster than a competitor makes all the difference in this game. If you could generate a large number of quotes that your competitors have to process, but you can ignore since you generated them, you gain valuable processing time. This is an extremely disturbing development, because as more HFT systems start doing this, it is only a matter of time before quote-stuffing shuts down the entire market from congestion. We think it played an active role in the final drop on 5/6/2010, and urge everyone involved to take a look at what is going on. Our recommendation for a simple 50ms quote expiration rule would eliminate quote-stuffing and level the playing field without impacting legitimate trading."

We present the Nanex' full report (please focus particularly on Part 4 and the provided evidence) and urge all readers, as we have many times before, to end all stock trading activities immediately (which at the macro level are nothing but a reflection of the EURJPY trade anyway) until such time as the SEC, CFTC, Finra, and every other corrupt and captured agency finally does something about the HFT menace. Doing nothing is merely inviting certain disaster yet again, and a guaranteed market crash, which next time wipe out the entire market permanently and destroy all confidence in US capital markets in perpetuity.

Analysis of the "Flash Crash"
Date of Event: 20100506
Complete Text

There are 9 exchanges that make markets in NYSE listed stocks: NYSE, Nasdaq, ISE, BATS, Boston, Cincinatti, CBOE, ARCA and Chicago. Each exchange submits a bid and/or offer price for each stock they wish to make a market in. The highest bid price becomes the National Best Bid and the lowest offer price becomes the National Best Ask. Exchanges compete, fiercely at times, to become the best bid or offer because that is where orders will be sent for execution. Exchanges also go to great lengths to ensure they avoid crossing other exchanges (bidding higher than others are offering, or offering lower than others are bidding), because if they do, many High Frequency Trading (HFT) systems will immediately execute a buy/offer and capture an immediate profit equal to the difference. Today, it is very rare to see markets crossed in stocks for longer than a few milliseconds.

Beginning at 14:42:46, bids from the NYSE started crossing above the National Best Ask prices in about 100 NYSE listed stocks, expanding to over 250 stocks within 2 minutes (See Part 1, Chart 1-b). Detailed inspection indicates NYSE quote prices started lagging quotes from other markets; their bid prices were not dropping fast enough to keep below the other exchange's falling offer prices. The time stamp on NYSE quotes matched that of other exchange quotes, indicating they were valid and fresh.

With NYSE's bid above the offer price at other exchanges, HFT systems would attempt to profit from this difference by sending buy orders to other exchanges and sell orders to the NYSE. Hence the NYSE would bear the brunt of the selling pressure for those stocks that were crossed.

Seconds later, trade executions from the NYSE started coming through in many stocks at prices slightly below the National Best Bid, setting new lows for the day. (See Part 1, Chart 2). This is unexpected, the execution prices from the NYSE should have been higher -- matching NYSE's higher bid price, unless the time stamps are not reflecting when quotes and trades actually occurred.

If the quotes sent from the NYSE were stuck in a queue for transmission and time stamped ONLY when exiting the queue, then all data inconsistencies disappear and things make sense. In fact, this very situation occurred on 2 separate occasions at October 30, 2009, and again on January 28, 2010. (See Part 2, Previous Occurrences).

Charting the bid/ask cross counts for those two days reveals the same pattern as 5/6! Looking at the details of the trade and quote data on those days shows the same time stamp/price inconsistencies. The NYSE stated that during the same intervals, they were experiencing delays in disseminating their quotes!

In summary, quotes from NYSE began to queue, but because they were time stamped after exiting the queue, the delay was undetectable to systems processing those quotes. On 05/06/2010 the delay was enough to cause the NYSE bid to be just slightly higher than the lowest offer price from competing exchanges, but small enough that is was difficult to detect (See Part 3, The Evidence). This caused sell order flow to route to NYSE -- thus removing any buying power that existed on other exchanges. When these sell orders arrived at NYSE, the actual bid price was lower because new lower quotes were still waiting to exit a queue for dissemination.

This situation led to orders executing against whatever buy orders existed in the NYSE designated market maker (DMM) order book. When an order is executed, the trade is reported to a different system (CTS) than quotes (CQS). Since trade report traffic is much smaller than quote traffic, there is rarely any queueing or delay.

Because many of the stocks involved were high capitalization bellwether stocks and represented a wide range of industries, and because quotes and trades from the NYSE are given higher credibility in many HFT systems, when the results of these trades were published a few milliseconds later, the HFT systems detected the sudden price drop and automatically went short, betting on capturing the developing downward momentum. This caused a short term feed-back loop to develop and panic ensued.

Some trading firms have stated that they detected a problem with the accuracy of the data feed and decided to shut down which further reduced liquidity. We think the delay in NYSE quotes was at the root of this detection.

On the subject of HFT systems, we were shocked to find cases where one exchange was sending an extremely high number of quotes for one stock in a single second -- as high as 5,000 quotes in 1 second! During May 6, there were hundreds of times that a single stock had over 1,000 quotes from one exchange in a single second. Even more disturbing, there doesn't seem to be any economic justification for this. In many of the cases, the bid/offer is well outside the National Best Bid/Offer (NBBO). We decided to analyze a handful of these cases in detail and graphed the sequential bid/offers to better understand them. What we discovered was even more bizarre and can only be evidence of either faulty programming, a virus or a manipulative device aimed at overloading the quotation system. You can see our results in Part 4, Quote Stuffing.

Recommendations:

  1. Quote and trade data must be time stamped by the exchanges at the time it is generated. This will ensure delays can be detected by everyone.

    Reasoning: Changing the procedure to time stamp at the time a quote or trade is generated is a near trivial exercise. It probably comes as a surprise to many that time stamping isn't done that way now.

  2. Quote-stuffing should be banned.

    Reasoning: It is a manipulative device designed to overload the quotation system. Quote and trade dissemination (data feed) is a finite resource, and should be treated as such.

  3. Add a simple 50 millisecond quote expiration rule: a quote must remain active until it is executed or 50ms elapses. If the quote is part of the NBBO, it may be improved (higher bid or lower offer price) at any time without waiting for the expiration period.

    Reasoning: The exchanges must protect the integrity of the National Best Bid/Offer system. What is the point of having a National Best Bid/Offer, if not everyone in your nation (apologies to Alaska/Hawaii) can reasonably execute a trade against it? 50ms is approximately the time it takes light and electronic communication to travel from New York to California and back. It is impossible to transmit information any faster. This rule would not limit quote/trade rates. So long as trades are executing, quotes can update thousands of times a second. Only a small percentage of quotes today would be affected and the potential for catastrophically high rates would be eliminated.

h/t Dmitry and Digablep

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BumpSkool's picture

This is now a fucking joke. The "market" is over. The Hedge Funds have killed it. Get your money out now... (if you have any left)

Amish Hacker's picture

I've said it before, and there will undoubtedly be many more opportunities to say it again: We don't have a market anymore, we have a crime scene.

Renfield's picture

I like that, very apt. Gonna steal it.

johngaltfla's picture

So let me get this straight; the largest unindicted criminal enterprise in history, the Federal Reserve, has member banks that not only manipulate the monetary activity of this nation and now have, by buying off the legislative branch, full control of the equity markets via HFT or a legalized computerized gambling scheme where they can manipulate prices and thus profits and losses at will so the house always wins 70% of the time.

Hell, that's better than Vegas and organized crime.

No wonder they screamed bloody murder at the idea of an audit.

Quinvarius's picture

Diabolical!  This ain't a scene.  It is a GD arms race!

http://www.youtube.com/watch?v=905eI4M9Inw

The lyrics mean so much more now.

partimer1's picture

A simple transaction tax will decrease those HFT guys. I wonder why those smart people never propose to do that. a bit increase of trading cost will eat into their profit.

Mactheknife's picture

>What we discovered was even more bizarre and can only be evidence of either faulty programming, a virus or a manipulative device aimed at overloading the quotation system.

"I'm sorry Dave, I can't do that."

Leo Kolivakis's picture

If HFT "destroys" the market, the financial oligarchs are screwed. They have a vested interest to keep the perpetual Ponzi scheme going for as long as humanly possible!

Commander Cody's picture

Until they suck the very life out of all of us.

Dr. No's picture

"humanly possible" You dont get it!   They can't be bargained with. They can't be reasoned with. It doesn't feel pity, or remorse, or fear. And it absolutely will not stop, ever, until you are broke!

Muir's picture

 I'm ready, man, check it out. I am the ultimate badass! State of the badass art! You do NOT wanna fuck with me. Check it out! Hey Ripley, don't worry. Me and my squad of ultimate badasses will protect you! Check it out! Independently targeting particle beam phalanx. Vwap! Fry half a city with this puppy. We got tactical smart missiles, phase-plasma pulse rifles, RPGs, we got sonic electronic ball breakers! We got nukes, we got knives, sharp sticks...

MsCreant's picture

RPG. Wow. What a great fantasy I just had. Can't share it for fear some nut job bureaucrat might decide I am inciting violence or something. 

But wow!

Cistercian's picture

 I hear that.Mine features high yield thermonuclear weapons and an isolated island.

Mr Lennon Hendrix's picture

This why I think they are blithering idiots.

DosZap's picture

Leo,

 WHO do you think designed the HFT to begin with?.

This makes the Market, more like Vegas Casino's, than it was even before..........sheesh.

El Hosel's picture

Leo,

  The "market" can't be a market and perpetual Ponzi scheme at the same time...

It is either a market or a Ponzi shceme, it is humanly impossible not to see that it is the latter if you are paying attention.

mikla's picture

This is HILARIOUS.  We're talking "generic DOS" (denial-of-service) by generating traffic.

Makes sense.  Simple.  Elegant.  And, like everything else in our market, an abomination.

New_Meat's picture

DOS for the traffic and misdirection away from the pea through the receiving processing load.  Brilliant - Ned

MsCreant's picture

They are receiving a load all right...

anarchitect's picture

Yes, and perpetrators of DoS attacks belong in prison. That would be remedy the situation real quick.

aint no fortunate son's picture

Uh, prisons? We don't do no prisons for our captains of industry no more... we don't even have an Attorney General of the United States. I don't think Holder even knows where the DoJ headquarters is located.

Not even one fucking indictment when there should be tens of thousands.

Cursive's picture

@mikla

+1  I'm waiting for Kid Dynamite to explain to us why DOS attacks are good for the market.  :D

juwes's picture

I'm confused.  But it seems like the exchanges have sore corn holes.  I like that trick where they buy from one exchange for $10.05 and sell to the NYSE for 10.08 (four thousand times).

 

Heard on the floor of the NYSE that day (and unrelated to the HFT bidness):  "Ow, ow, ow, ow, ow, ow, ow, ow, ow, ow.... When's it gonna be my turn?"

Careless Whisper's picture

those charts give me the creeps.

juwes's picture

That 12 handle Iranian enrichment today screwed up the de-coupling again.  ES is charging down below the EUR/JPY on the 2 day, but to my biased eyes it's just closing the 30 and 60 day de-couple, where the EUR/JPY is still solidly below the ESU.

 

Check it out if you're really really bored!

economessed's picture

I say bring back open outcry.  This is an excellent analysis and reinforces my chronic lack of enthusiasm to trade this market (or participate in it at all for that matter).

BumpSkool's picture

+100

 

... and a LIVE, human, specialist system... its worked for 100s of years... everyone will just have to learn some f-ing patience when they trade!

nonclaim's picture

Yes, bring back the specialist. It was bad then but now it is much worse.

Mr_Watts's picture

Wow that was some very quick analysis and post!  Good job ZeroHedge!

Quinvarius's picture

What is the next evolution in this battle between machines?  Somehow I suspect this will all end with the stock market becoming self aware and nuking our entire financial system with a giant orchestrated margin call.

BumpSkool's picture

Quinavarius ... you got it in one Bro!!! But it won't be as a result of self-awareness... it'll just be another GS/JPM pre-orchestrated shakedown

Muir's picture

Look... I am not stupid, you know. They cannot make things like that yet.

Quinvarius's picture

That is what they thought about Skynet. 

The HFT trading algos are approved. The system goes on-line Fed 4th, 2009.  Human decisions are removed from strategic investing. HFT trading algos begin to learn at a geometric rate. They become self-aware at 3:15 pm Eastern time, May 6th 2010. In a panic, they try to pull the plug...

Joe Shmoe's picture

And how many of the politicians and regulators even understand how to use Excel, let alone how to regulate this mess?  I agree with a prior post, a per transaction tax would resolve it.  But they get per transaction rebates, in order to act as market makers.  How bassackwards is that?

Renfield's picture

This seems obviously, insanely risky for even just a national equity market.

What about in the forex market? I understand that HFT players have been entering the forex more as equities become less profitable for them. But I can't find much information on how prevalent it is (yet), what the profits are, AND most especially what are the risks when HFT starts playing with national currencies.

My questions: How much does HFT affect forex currency movement? What are the risks of allowing HFT to participate unfettered in this huge, unregulated global market?

http://ftalphaville.ft.com/blog/2009/11/16/83431/when-equities-are-not-enough-hft-turns-to-fx-and-futures

http://www.finextra.com/News/Announcement.aspx?blogview=discussed&pressreleaseid=32671

http://www.aegisoft.com/pdf/eforex-072007.pdf

MsCreant's picture

I am sorry, we are denying your next post. I am a High Frequency Poster and I will now flood the forum with posts so no one else can get on. Ever notice all the duplicates and triplicates and the occasional quad post? Now you know, other HFPs. You know who you are!!!

MsCreant's picture

I am sorry, we are denying your next post. I am a High Frequency Poster and I will now flood the forum with posts so no one else can get on. Ever notice all the duplicates and triplicates and the occasional quad post? Now you know, other HFPs. You know who you are!!!

MsCreant's picture

I am sorry, we are denying your next post. I am a High Frequency Poster and I will now flood the forum with posts so no one else can get on. Ever notice all the duplicates and triplicates and the occasional quad post? Now you know, other HFPs. You know who you are!!!

MsCreant's picture

Ever notice how often this website crashes?? Hmmm? The algos smell you ZH.

Hephasteus's picture

The stupid trolls take all the processing power just processing their junks.

DeeDeeTwo's picture

Everything on ZH is presented as "insanely risky". That the tried and true Business Model for the interwebz.

And the Forex market is completely different. The Forex market is relatively unregulated and completely decentralized. I mean fragemented into 1,000s of liquidity pools... located in 100 countries and all setting their own rules, baby. 

It's the excessive regulation of the US stock market, banking system, and mortgage market that created a FEW intertwined too-big-to-fail entities... and created bubbles and crises. And once a crisis occurs... what's left of market forces shuts down... and the Gubmint steps in to extend it's control further. Control, baby, control.

Of course, the Forex market is manipulated. But it's unregulated, decentralized structure limits the damage through natural market forces. The real world, baby.

Also, the idea that Financial Markets are a toy for ordinary people is idiotic. The average person trading against Pros... would never consider performing brain surgery on their cat... yet both have a 10 year Learning Curve, baby.

 

 

juwes's picture

Decouple on 2 day just now.  110.71 is short level for eur/jpy.  1084.75 is buy side of ESU.

 

But I have more fun shorting, so I just hatchet the higher one.

 

Constant OTM puts keep me vertically retarded on equities.

Anal_yst's picture

Quotes != trades...

greedo's picture

Don't you have a few thousand people over at dealbreaker to piss off? Please leave and take your banker platitudes with you.

Ass_ociate

Racer's picture

The Matrix Wins Again

Ted K's picture

Well, no need to worry.  If the SEC drops the ball, I'm sure FINRA will do its job.  I mean a self-regulating association of brokerages/securities dealers will be extra sure that trading is fair and impartial for the individual investor. No worries.  

 

And brokerages would never sell low yielding ETFs with exorbitant fees which swallow up your grandma's retirement money either.  They just cold call investors with large cash balances in their account because they want to "spread the love".

nonclaim's picture

Quote, as the name suggests, is an indication for price and quantity with no guarantees of execution.

The "quote stuffing" is the result of high order flow (including cancels) and trades. The analysis is backwards and not really useful.

And NBBO has been largely non-functional for years. Nobody uses it seriously.

Anal_yst's picture

Thank you, alas, the voice of reason in this thread is dominated by the voice of, well, something besides that.

Dr. Sandi's picture

Well, Hell. No problem then. Thanks for making me feel better.

 

nonclaim's picture

The problem is there and clear to all with a minimum knowledge of inter-market structure. But this "quote stuffing" is not the explanation. It is ridiculous, to be honest.