More Are Waking Up To HFT Terrorism: Iridian Asset Management's Latest Investor Letter Blasts High Frequency Trading

Tyler Durden's picture

In their Q2 letter to clients, Jeff Silver and Ben Hunt of Iridian Asset Management provide an update of the fund's performance and some notable holdings (long: TOO; short: TXT) but the core of the letter is the recap of the firm's "Hollow Market" theme, this time refocusing on what we have long claimed is the biggest threat to market integrity, High Frequency Trading: "On May 6th we saw the hollow market revealed via the so-called “flash crash”, where liquidity throughout US equity markets vanished in the time it takes to turn off a computer server running a high-frequency trading algorithm. As we wrote to our investors that afternoon, we believe that it was the interaction of trading algorithms, ETF’s, and decentralized venues that created the flash crash." The firm proceeds to highlight the two outcomes of what is now known as the Hollow Market paradigm: i) a constant, non-trivial chance of severe market dislocation (which includes a reference to the seminal paper Is High-Frequency Trading Inducing Changes in Market Microstructure and Dynamics, first posted with comments on Zero Hedge, and ii) the need for a Tobin tax, another topic long endorsed by Zero Hedge as a means of fixing the market. Furthermore, all those still confused by Zero Hedge's fascination with VWAP strategies, can finally sleep well after reading this letter. All in all, a must read analysis for everyone (and even the two employees at the SEC with an IQ greater than single digits), curious as to how screwed up our current market truly is  (also, thanks for the shout-out).

Full Letter


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Panafrican Funktron Robot's picture

Another similar concept taxation scheme that I've been advocating lately.

Sudden Debt's picture

and even the two employees at the SEC with an IQ greater than single digits

The boss has send them on a mission to return the porn DVD's and get some new stuff.

Leo Kolivakis's picture

"We are under no illusions that these actions insulate us from deleterious systemic consequences of a hollow market. But we do believe that these steps make a difference, and we continue to explore ways in which we can better protect our intellectual property from the in-broad-daylight theft perpetrated by HFT algorithms and current market making structures."

Excellent letter, kudos to Iridian Asset Management and to ZH for posting it.

spekulatn's picture

+1  (Looking around nervously)



Doode's picture

Just a bunch of excuses for their own crappy results. HFT is just another type of trading that people do not understand, and what they do not understand they fear and use as a scapegoat. There are many underlying currents in the markets that change all the time and some market participants fail to recognize them and then go out and blame it on the latest fad called HFT. Very typical - they should work harder and not tell the world that dog ate their homework. Too lame, and zerohedge folks should not fall for it either. I remember in 2004-5 it was those "evil hedgefunds" pumping the price of oil when it ripped above 40. Turned out there was a reason for all of it later on. Every time the market is changing there is an "evil perpetrator" that takes money away from legacy participants - you gotta be able to look at yourself from a side to recognize the ridiculousness of those claims. It is much harder to get a fill on the limit order these days, but going market on smaller spareds allows for far greater market orders to get filled on the cross. HFT really traded price for liquidity - adjust your style and move on to higher highs instead of bitching about it.



Leo Kolivakis's picture


I don't know about Iridian's performance, but for disclosure purposes, which prop desk or hedge fund do you work for? One more thing:

I remember in 2004-5 it was those "evil hedge funds" pumping the price of oil when it ripped above 40. Turned out there was a reason for all of it later on.

I remember it too. I was getting bombarded to participate at "commodity conferences" where the usual suspects were touting how great their commodity indexes are. Pensions shoved billions into these indexes, influencing the price of oil futures. Pensions also shoved billions into Commodity Trading Advisors (CTAs), which were playing the momentum game. To ignore the flow of funds is simply ridiculous.

Mark my words: All these billions being plowed into HFT platforms and hedge funds will come back to haunt us.

Doode's picture

As my alias Doode so eloquently suggests I prefer anonymity without hiding behind it too much. I work for a place that trades more than 1 billion shares a day globally (sometimes 1.5 billion on NYSE/day on a busy day) - buy side. Is that big enough for you? We trade every strategy from HFT to momentum, beta, alpha, etc. And I worked on a sell side doing execution algos that traded very heavy volumes.

Every aspect of market can come back to haunt - credit crisis did that to equities, sovereign debt is a problem now, social security can BK the nation, Bernanake QE 2,3,4,5 might lead to bad things.. Earth might collide with an asteroid in the relative near future. Every breath every man on the planet takes leads him/her closer to demise. So? If people are saying that trusting computers can be dangerous well then let me assure you that everyone been entrusting their lives to them for decades and we are better for it in our every day lives. As per liquidity disappearing during last crisis - it was not the computers that pulled the bids, but humans. I happen to know a few personally that gave an order to pull because things did not make sense. Ergo, blaming everything on machines reminds me of ludite movement - pointless and even dangerous. That is not to say that HFT participants can do anything they want, but as long as they operate within market rules people should not be bitching about them, but instead embrace them and adjust to them.

Leo Kolivakis's picture

"That is not to say that HFT participants can do anything they want, but as long as they operate within market rules people should not be bitching about them, but instead embrace them and adjust to them."

I have my doubts on "embracing them", but definetely agree with you that we have to adjust to them. My biggest concern is who is monitoring them???

Doode's picture

SEC - the same people that do it right now. If they cannot do it then its the government's problem, so "caveat emptor" is as important today as ever with financial markets.

StychoKiller's picture

Peter Lynch once said that you should not buy shares of a company that makes money doing something you do NOT understand.  I bailed out of the stock market because machines are doing things I do NOT understand.  I happen to have close to 30 years of programming experience and I can see that whatever is going on is definitely NOT for my benefit!

RottingDollar's picture

Spoken like a kid who has only be in the markets since 2000.  Markets have been breaking down for 10 years now as investor confidence has slowly wasted away.   HFT just one of many nails in that coffin        

But thanks for the pollyanna post.   Gives me optimism that there will still be suckers out there I can trade against. 


Doode's picture

Markets are "so broken" that trading volumes have trippled since 2000. They are not broken - they are different.

old_turk's picture

"HFT algo’s do not work at all when there are only sellers and no buyers, because there is no one available for the algo to offload the exposure. But when there are no fish in the

quote depth, the HFT algo’s just stop fishing. They simply turn off. As a result, all that liquidity that everyone thinks exists in this hollow market simply vanishes."


And there you go, a great analogy and a great article.

Of course, the market being a zero sum game with leeches sucking off real capital everyday ... doesn't that mean that at some point, the reset button gets hit, just because?

We live in interesting times.

Thomas's picture

Very entertaining. I got to denounce the crime syndicate in the WSJ right after the flash crash in my ten minutes of fame...

Wiedner is right: I am "in the extreme"

Hephasteus's picture

But all they want is pricing power in the face of millions of people saying fuck you. How else can they be certain that thier assets only go up and never down. What's the point of effortlessly stealing money if you run a risk of losing it.

Slartibartfast's picture


Well, nuclear power seemed like a great idea too until it was realized that unsavoury characters could make a 'bomb' out of it. Once again, a new idea gets implemented without any analysis or forethought and the 'unforseen' downside far outstrips the much ballyhooed upside. Kitchen table investors marginalized once again...

DavidC's picture

Drums and Wires, eh?

One of my favourite bands, Andy Partridge one of music's most eloquent and erudite individuals.


Cognitive Dissonance's picture

More Are Waking Up To HFT Terrorism: Iridian Asset Management's Latest Investor Letter Blasts High Frequency Trading

Tyler, didn't you get the memo? Only brown, black, yellow and red people are terrorists. White Anglo Saxon's are business men and women as well as consumers.

We now return you to your regularly scheduled programming already in progress.

<Blatantly obvious sarcasm>

Thoreau's picture

Nothing will be done as HFT is the enema of choice for market constipation. Yes, it is a double-edged sword, but it's currently being wielded for the upswing, with the occasional cut to keep the plebes and politicians in line.

cookies's picture

Let's be sober about this.  There are many different HF trading strategies and it is important not to tar everything HF with the same brush.  The tight spreads and reduced cost of trading stocks help to improve markets in many areas that people don't normally pay attention to:  hedging options positions, enabling cheaper ETF or basket hedges.  If anyone says that they do not care about options, well, they should; or at least go find out what the annuities business is all about.  The basic message is that markets are intrinsically linked and it is very dangerous to mess about structural things like transaction costs without a clear understanding how it impacts the rest of the market.  It is also up to the retail brokerages to update their links and provide quick and clever execution to the public if they are not already doing so.

One other major point that may escape the general public.  Many of us may not have been actively trading during the 1987 crash - I don't think you can blame HFT for that but you can see a lot of similarities in the behaviour of traders during that crash.  Whether or not it is a human not trading or a human unplugging the machines in 2010, it is a normal trading reaction to this anomalous event.  For those who argue that humans would behave differently during the flash crash, please read below:

In a report "A Brief History of the 1987 Stock Market Crash with a Discussion of the Federal Reserve Response" by Mark Carlson [2007], the author pointed out that the macroeconomic environment leading to the crash event was uncertain and largely unfavourable to equity investors and the markets had been in decline over the prior week to the crash event. In addition, the document describes two, then, new financial innovations that may have contributed to the event: The first was the increasing use of 'portfolio insurance' strategies using automated stock program trading systems, and the second was the 'index arbitrage' program trading strategy. The single biggest flaw in the portfolio insurance concept is the capacity of the market to absorb massive flows of trades in the same direction.  In "Remarks of David S. Ruder, Chairman of the US SEC" dated February 18, 1988, it was noted that during the october 1987 crash, there were complaints of market disfunction with specialists and market makers unable to maintain a orderly functioning market.  A direct quote from that paper:

' Specialists told us that, although their function is to maintain a fair and orderly market, their responsibility is to alleviate temporary market imbalances - not to prevent significant changes in market perceptions from being reflected in stock prices. Therefore, the question becomes how smooth a transition from one price to another the specialist should be expected to provide in rapidly rising or declining markets. All six of the specialists we spoke to said they do not see themselves as the buyers of last resort in markets such as that of October 19. This view was generally supported by broker/dealers we spoke with.'


'The six specialists we spoke to said their capital during the market crisis was sufficient to perform their role of maintaining fair and orderly markets. They said that even with additional capital, their actions during the crisis would not have been significantly different. They added that, given the market trend on late Monday, October 19, and mid-morning October 20, it would have been suicidal to continue to buy when the entire market wanted to sell. For example, one specialist indicated that on Tuesday, just prior to calling a halt in trading, he was facing, just in the crowd of floor brokers, orders to sell at least 500,000 shares of one stock, without any buy orders. Also, one SEC official said it is not reasonable to expect specialists to engage in “kamikaze” trading strategies.'

So, there you have it from the horses mouth.  There is nothing sinister about the HF machines or the humans behind them.  When all hell breaks lose, whatever the specialists want you to believe, I don't think they will stand in to fill in the gap - or at least their predecessors have admitted that they have not done so.

I can go on about the stupid follow the herd long-short stat-arb funds that have been crying over the last couple of years blaming all and sundry for their bad performance.  The important thing is to get our facts straight before we destroy what we do not understand.




MichaelG's picture

But on May 6, if it made so much sense to sell & not buy, why did the market go straight back up again?

Grand Supercycle's picture

As first suggested on Thurs 26th, further upside for DOW/SP500 is expected.

radsz's picture


One of the best reading I had for a year and I read a lot.



cookies's picture

People buy for different reasons.  I know that there were option traders who were long gamma and they are net short and they started buying once the market came back.  So did the shorts.  In a lot of cases, it wasn't clear if the market was going to shut down early so it is better to close out a winning position than to expose your portfolio to more uncertainty.  As the bids start to appear, this builds up the market and because the market was still thin, it is not surprising to see a bounce. 

Note that if it wasn't for the shorts and option traders, I would find it difficult to believe that there were 'fundamental' traders or investors who would willingly put in a bid for a market that had dropped so far.  Speak to your grandma or your investment advisors and ask them if they had recovered from the shock to do anything.  A normal 'long' only fund or investor would have participated in selling into the sell-off, causing more damage, and sat out for a few days before dipping back in there.

I reiterate my point:

1. You cannot rig the market to benefit only one kind of investment or trading.  You need an ecosystem of traders who could benefit from different situations so that there would be a healthy volume of buyers and sellers at any point in time.

2. A market completely dominated by HFT is not healthy; so is a market dominated by big funds who could swamp the market at their whim with huge amount of capital.

3. If you cause the market to be dominated by long-only investors with long term time frame, good luck finding the other side of the trade and in certain situations, everyone will be chasing the same trade.  Again, good luck getting out. 

4. Large trades and consistent buying/selling pressure in a short amount of time is more dangerous to the market.  Instead of focusing on volume, looking at net buy/sell volume during that period.  Ask yourself who is net selling into that market - it is more likely to be your friendly next door 'long' only funds unwinding desperately than the nasty HFT.



MichaelG's picture

All fair comments!  (I particularly agree with your (3) - blaming 'shorts' for all the world's woes is the typical sort of easy-headline scapegoating which is a mainstay of politicians in any sort of a crisis.)

But back to May 6 - which of the various players you mention were able to bring ACN down to a cent?  Also, do you disagree that there is either:

i) a constant, non-trivial chance of severe market dislocation...


ii) the need for a Tobin tax, another topic long endorsed by Zero Hedge as a means of fixing the market 

to which I'd add:

(iii) the need for some sort of sensible minimum-time requirement during which any posted bid or offer has to remain 'live'.  You mention 'short amount[s] of time' - is there a way in which such a requirement would be damaging to the healthy function of the market?

PS Grandma was unavailable for comment! :o)

cookies's picture

I have too much to say about regulating the HFT cash traders.  I am aware that my comments are taking too many inches here.

I just want to try to reframe how we should think about the markets and thus, hopefully, everyone can stop trying to kill one species in the ecosystem.

1. We should think of the market as a utility;  for example, the electricity grid.  Anyone wishing to buy/sell would be using this utility.  Think about it, what is stopping the whole grid coming down every so often?  It's about limiting and regulating how much each individual, factory, installation, that taps into this utility, uses this utility.

2. It's not about volume - high two way volume is actually healthy.  Putting a stupid Tobin tax is actually going to kill the market because it does not discriminate between dangerous one-direction overload on the market and normal efficient functioning.  What you want to regulate or price is the maximum load in one market direction.

3. No sensible utility authority is going to let anyone build a factory that can pull an arbitrary amount of electricity from the grid.  That is what is happening now.  It is incredibly stupid how the regulations are currently - just because you can prove you can pay for the 'electricity', you can pull down as much as you want.

4. You need to regulate maximum size, net in one direction, across market products (ie, futures, options, stocks) in a 1min, half a market session and a full market session.  This will limit the size of the stupid funds or banks that have grown way too large. 

5. If you want to tax something, have a hard limit based on (4), and then have a tax scale based on the one-directional accumulated order size.  You pay more for what you draw from the market.

6. HFT algos that act as market makers are like capacitors.  This is how it works - in order to have that magic utility that has buyers and sellers whenever you want to dip in, there must be sufficient economic advantage for someone to take the risk of matching buyers and sellers over time.  The shorter the time frame, the less the risk and thus tighter the spread.  You don't want to destroy that.  You want to make sure that things are fair - hint, do you know how many order types are there on the exchanges?

7.  Last point: Any algo that generates two way (buy/sell) volume and is neutral over a short period of time is like a generator.  The large directional hedge funds are actual users of this utility as are the retail customers and investors.  The latter do not help make the market.  It used to be market makers and specialists that generate the utility and this role has migrated to algorithms and computers.  If you have a regulatory limit and tax on large unidirectional draw on the utility, you can stop the damaging hits on the markets as well as the oft-accused momentum chasing algos pounding the market.

BTW, I am not involved in HFT in cash markets.

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