Scientific Proof That High Frequency Trading Induces Adverse Changes In Market Microstructure And Dynamics, And Puts Market Fairness Under Question

Tyler Durden's picture

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thesapein's picture

Wait, what? Only now are financial analyst applying fractal math? Man, this field is wide open for some seriously cool science if experts in finance and trade really see this as novel stuff. Then again, they're still treating Fibonacci as new thing, so, yeah, time for some upgrades. 

currency conflagration's picture

Maybe Apple can help them out with a fractal app!

thesapein's picture

(Just using you (cc) as a stepping stone and being honest about it...)

You know, from a nube's perspective, it kind of looks like a duh moment because, of course, if the time frame is shortened, why wouldn't we expect to see a self similar pattern? HFT allows for a more dense curve, or more points within a frame, so unless HFT uses different rules it should show, after zooming in, a similar curve, just on a different scale, no?

Also, Tyler, give yourself credit for already shining some light on the dominance in the market of HFT before this paper was written. 

ThinkAVP's picture

Tyler, CRUSHHHHING IT!!!! one post at a time..


"ON a long enough timeline the survival rate for everyone comes to Zero Hedge"

thesapein's picture

I feel like throwing a ZH party.

ThinkAVP's picture

LET'S CRUSHH IT!!  I'll Bring the ZH chicks..

ThinkAVP's picture

Tyler, I need a ZH Application for my IPhone,  ill gladly contribute to the CREATION!!

Cistercian's picture

 Great job is always great to be way ahead of the pack.

  Even if it only confirms the dystopian financial slave labor camp I live in......

Eric Cartman's picture

Wow, compelling shit! Also, just a side note - wtf is up with the ugly bitch on Bloomberg that I have to watch for the next 3 hours? Why can't they keep the hot chick that is on from 12a-1p!? God damn, I like her a lot. I bet if she was given that time slot, she'd drive those Asian markets straight up!

vs18's picture

I will donate constantly if you posted more stuff like this... keep it up Tyler.

bob_dabolina's picture

Basically, that stock picking course I took as a lad at Eagle Brook is pretty much the largest waste of my time to date. Also, my economics courses from college, my business courses, and...well..ay y not just fuk the speling clas frum fort grade

Testicular Cancer's picture

Economic Skynet boys. Someday, it will become self-aware.

Cursive's picture

What is most troubling, is that micro similarities, as postulated by non-linear theory, tend to rapidly evolve into massively scaled topological disturbances, and thus a few simple resonant trades can rapidly avalanche into a major market destabilizing event.... such as that seen on May 6.

If HFT is 70% of all NYSE trading activity, then there is an obvious market propping bias (would have said long equity, but HFT doesn't hold overnight or for more than a few seconds for that matter).  What makes the HFT ignore selling volume and buy up the dips?  Or do prop trading desks know how to trick the HFT to do their bidding?

gs_runsthiscountry's picture

3X Levered Index ETF's - like stuffing a .50 caliber round into a .22.


Zombies On Toast's picture

Knowing this, the question then becomes can some HFT shop force a blowup, or crash, by applying the correct perturbation at the right time? Is that possible, or not? Yikes!

bob_dabolina's picture

Or can a collusion of big hedge funds throw off PD's HFT by simultaneously ramping or dumping certain stocks/ETF's?

bob_dabolina's picture

Or can a collusion of big hedge funds throw off PD's HFT by simultaneously ramping or dumping certain stocks/ETF's?

thesapein's picture

The answer is already in the pattern, if its fractal. The short answer is yes. If you see what looks like big moves in short time spans, then you can see magnified moves on large times scales. Not good if its more than noise...

mephisto's picture

Absolutely they can. And if they all have simlar code, they all do similar things at similar times, they may not have to mean it for it to happen. Hence the flash crash. Deliberately causing a crash rather than just getting so incestuously linked together in the order book that one happens anyway - that's the step that (probably) hasnt happened yet.

Never mind. Don't worry. Just by Alcoa. They dig shiny stuff out of the ground and sell it and make no money. Buy them, they're coooool.

ThinkAVP's picture

THIS IS CRAZY!! Algorithmic trading would be used in any investment strategy.. I guess we are better off using the MAJIC 8 BALL..


This still doesn't prove much, in 2008 alone  Black-Box trading brought in roughly 21Billion in profits in 2008, in 2009 high frequency firms account for 73% of all U.S trading VOLUME.. 20% of all options volume are now on this along with Foreign exchange markets..  THE MAJIC 8 BALL, thats prob what we will need or how about that octopus that predicted the world cup all we need is every trading firm to have one and WALLLA $$$$$$$$$$$$$$$$$$$$$$$$$$!!


It's ok!! Failure is what makes us.. No need to re-invent the wheel just need to make this $hit better!!





TraderTimm's picture

The implications are staggering. It may be that there is a given 'tipping point' that could indeed trigger HFT-cascades. But given the chaotic nature of initial conditions, it would be nearly impossible to solve it in advance to either profit from it or defend yourself.

Looks like we're back in the stone-ages for intraday market forecasting, hoping the HFT lightning doesn't toast our comparatively underfunded accounts in one go.


thesapein's picture

Oh, my. I just realized that your "tipping point" may actually be irrelevant if it is indeed based mostly on fractal geometry, or enough to be significant, because as long as you can see large volatility (variance) in small time scales, then you could see these same spikes on ever larger scales. Oh, my. 

thesapein's picture

(After two glasses of wine and rereading the paper...)

Hey, everybody. You know what else this means? The stock market could rally or crash no matter the health of the economy. No, really.

Caviar Emptor's picture

Wink wink! See my other post

thesapein's picture

(After taking a few more hits...)

Okay, this is not important if you're a rock, but the implications of this paper are continually surprising me, mostly because I'm now feeling stupid for not seeing it first.

If fractal geometry is applicable to the stock market, then it is only a matter of time before an extreme event will occur. To see this, just imagine any fractal pattern, like say, a sea shore. It may seem to be running North and South, but eventually it makes a significant turn, heading East and West. No matter how much you zoom in or out, this is always the pattern. The question that maybe concerns us most is when does the continental shift occur?

Caviar Emptor's picture

...and melding your brilliant insight with Soros reflexivity theory of markets, we can conclude that HFT bots trading with other HFT bots must inevitably result in catastrophic market imbalances. And those tend to implode. Timing it is a matter of not drinking the Kool aid when all the bots are leading the children over the cliff

thesapein's picture

Nature seems to work that way, doesn't it? I suppose catastrophe has its purpose.

Troublehoff's picture

Yep, but nature doesn't 'back out' catastrophe transactions like those exchanges do.

fajensen's picture

The question that maybe concerns us most is when does the continental shift occur?

No, What actually concerns me is this:

Over time I spend several grands on option bets because I know that eventually the shift will come and the bets will pan out. The magick day arrives - I Am Rich - for a few minutes until my trades are cancelled because "obviously" the pricing was abnormal, a statistical oulier, a loss for Goldman Sacs e.t.c.

So, what the f*ck is the use being in this market?? It's loose, loose always!!

drwells's picture

The amazing thing is that the equity markets haven't been subjected to the run they richly deserve. I'd bet more than a few institutions that have already gone under were more honest and solvent than these fecal Babels.

TraderTimm's picture

The kicker is when all timeframes look exactly the same. Superimposition of a massive correlating wave down or up that reinforces itself via feedback.

Forgive me if you've already stated this in another way already, it is a bit late for me :)


thesapein's picture

Now, I see better why stops are becoming more of a topic, as Tyler already knew. Next though, they'll come up with ways of trading around stops, which means, back to the drawing board.

zhandax's picture

As Scotty said, "The more they overthink the plumbing, the easier it is to stop up the drain."

mephisto's picture

Impossible? Not really true - there are guys out there passively waiting for signals that a market is approaching a critical point. Of course you can't predict one exactly, but certain market moves are strong signals for these guys.

It's very smart, still rare, and so far has a good hit ratio. It's been around since about 2006. The academic papers are all there for those with the patience and some maths skills. For those who don't have them, it looks weirdly like Elliot wave "theory". 

FreakuentFlyer's picture

I predict that the average quality of responses to any ZH article has a negative correlation with the number of responses to said article.

I also predict that ZH's ignorance of the previous prediction will be positively corelated to whatever SEC blame is most popular at ZH during the week of the said article.


Edit: My "last" prediction is that we will have market crashes in the future, unlike any crash before the given crash.



thesapein's picture

As processing power increases, the more dense the curve over time. An event that may have taken years could happen in minutes. Perhaps, your last prediction would had already occurred had someone not been able to pull the plug on several occasions. That off button is going to get a lot more use. 

Caviar Emptor's picture

Super job, Tyler! Impressive 

HFT is the ultimate demonstration of Soros' Reflexivity theory in action. Anticipation of events can make events happen that otherwise wouldn't in self-reinforcing ways that sway the market toward huge imbalances.

Of course the absurdity is even beyond Soros now because HFT is becoming auto-reflexive: HFT bots anticipating and factoring in other HFT bots and their own anticipation of other bots. Hence bots anticipating themselves. Since human stock market participation is now almost non-existant, the stage is set for even more self-reinforcing, untethered HFT reflexivity.  Which, according to Soros, can lead to a state of dangerous imbalance. Think Flash Crash! What a feeling .....coming soon to a theater near you. Also coming soon: Flash Dash! Where the market moves 800 points in a day on biz as usual. 

thesapein's picture

You mean like a feedback loop? I'd say we're always operating with a standing wave that could turn into a feedback loop.

Caviar Emptor's picture

Yeah...a positive feedback. Soros' point is that rather than the market being some objective judge of economics, the opinions and actions of investors in the markets can sway events. So if everybody thinks IBM is going to 900, that fact alone and nothing else can sway the price in a self-reinforcing way...until it doesn't. He used this to explain events in 2007-8 too. 

My point is now HFT bots can reflexively affect the markets (as we all know) but there's a new twist: they affect each other and affect themselves by affecting other bots. So if you tune an algo, you might set it to expect a buy proggie if you place a trade under certain conditions. Then if there's another buy proggie initiated, you could set the algo to buy. If all the algos are set this way by coincidence, you can get 800 points in a day or weirdities in sectors

thesapein's picture

This is beautiful.

It's something we've come to expect from human bots, leading to bubbles and pops, but now we've got to use game theory for among the robots? It was bound to happen.

Bearster's picture

How many, and how big, regulatory failures before people see that regulation itself is impractical, unworkable, and immoral?

While it hurts the legitimate businesses, it gives crooks lots of places to hide.  And in any case, it cannot compensate for structural problems elsewhere.  For example: ZIRP, TBTF, trillions of dollars of "liquidity" that is "pumped into" the market, the regime of irredeemable fiat paper currency, moral hazard, SEC/CFTC/FDIC/OCC/OTS, numerous other regulatory agencies, hundreds of thousands of pages of regulation, etc.

In reality, nothing would be improved by forcing the activity described in this paper to happen at a slower rate, and in any case, you can't put the computer genie back in the bottle.

Does anyone believe that today's market could ever go NO OFFER?  If not, why do you think it went NO BID on May 6 (and will again, probably soon)?  Is HFT the root cause of this, or is there another more fundamental cause of a NO BID market?

firstdivision's picture

Yes, becuase not regulating worked out so well and deregulation turned crooks into saints.  We did not regulate dervatives when someone noticed that they were getting out of hand far before the crisis.  CA deregulated their energy and that went so well.  Deregulated the banking wall that allowed TBTF.  You obviously fell inlove with Ayn Rand like Greenspan and fail to see reality from the tip of your nose. 

Now if you were bitching about the worthless regulations on the books, I would agree with you.  But to state that all regulation is bad and causes crime and pain.  Well then we are far from agreement.   

thesapein's picture

Judge Napolitano says that to regulate should be merely to make things regular. Some amount of regularity seems needed. However, the power to regulate is not a power any one person or group should have unless you can trust people to not give in to abusing this power.

carbonmutant's picture

We should be getting close to a wave function collapse...


Caviar Emptor's picture

Shhh! Don't say "collapse"... They might hear you....

thesapein's picture

A measurement of the real economy might collapse the wavefunction. Kind of feels like we're in quantum flux.