Having been the first to warn the world about the perils of high frequency trading nearly 5 years ago, when momentum ignition, layering and quote stuffing were still incomprehensible buzzwords to all but a select few algo traders from Citadel, GETCO and DE Shaw, and warning about such top-down systemic lock ups like flash-crash over a year in advance; as well as the bottom-up impacts of 20 year old math PhDs being in charge of market topology, our crusade from the micro has since shifted to the macro and the primary nemesis of all that is free and fair, the Federal Reserve. In the intervening years, traders such as Haim Bodek opened the HFT kimono even more publicly a few years ago. The following is a must-watch documentary for every investor and trader to comprehend just what it is (and who it is) that drives stock prices day in and day out.
Recent speeches from the SEC indicate they plan to use Midas to look at the details behind quote stuffing, excessive order cancellations, the cause of mini flash crashes, and other nefarious activities. While these are all good uses for a market analysis tool (Midas), they pale in comparison to a data-feed delay analysis, because the former are governed by blanket, hard-to-prove manipulation laws, while the latter can be tied directly to a core rule that lies at the heart of Regulation NMS. An improper data-feed delay was the reason for the $5 million fine against an exchange in September 2012. Furthermore, millions of people are directly affected and disadvantaged by illegal data-feed delays. Therefore, it would be a great waste of public resources to not immediately pursue a data-feed delay analysis, because there exists ample evidence that an illegal speed advantage exists in direct feeds over the public quote.
It has been almost 2 years since FINRA started to get 'serious' about thinking about looking into an investigation of (get our point) high-frequency trading and dark pools but it seems, as the WSJ reports, this time they are more specific. In Sept 2011 FINRA noted "there's something that's troubling us in the marketplace," and it seems now that FINRA has spent the time since understanding the jargon they have some questions, "who is responsible for the automatic shut off or kill switch," asking firms how they avoid "quote bursts and stuffing" that create confusion for other investors and potentially distort the market, and approving a plan to force dark pools (15% of all stock trading) to disclose and detail trading activity on their platforms. Of course, we've seen this kind of bluster before and they did nothing then but hope springs eternal.
The major compression in VIX into the close combined with a complete lack of JPY-based carry-driver for the equity market comeback today has many asking just what happened? Though the mechanism for quote-stuffing or momentum ignition in this case is unclear - one thing is absolutely crystal clear - today's total and utter explosion in the quote volume for SPY options provides more than a little concern for just what this market has become. As Nanex notes, over 1.1 billion quotes for SPY Options were posted today as 'quote spam' seems to be serving as some kind of parasitic momentum spark. The point here is that just as the market's flash-crash occurred on a day in which quote-stuffing in cash stocks hit a record; so today we got the inverse flash-smash higher in stocks from a surge in quotes on the far-more levered options market. Just look at these charts!!
While most of the US was in deep REM sleep, the Germany stock index, the DAX, had a flashback to May 2010: starting at 3:44 am EDT, in the span of 6 minutes or much faster than the gradual drop that led to the US flash crash from three years ago, the DAX went from well and solidly-bid to having zero liquidity... and dumping nearly 200 points in the process. Whether it was rumors of a (subsequently validated) rating agency downgrade, or just an algo testing its quote stuffing ability, the moves showed vividly that when the current rosy paradigm shifts abruptly and violently, all those hoping to be the first out of the door and hit the sell button, simply won't be able to do so. Because sadly there is no such thing as a free "4 year long zero volume levitation" - one must always pay the piper in the end.
After exposing the stock market manipulative arsenal that is High Frequency Trading, quote stuffing, flash trading, packet churning, layering, sub-pennying, liquidity, latency and dark pool arbitrage, NBBO and Reg NMS exemptions, "hide-not-sliding", collocation, and much, much more for four years, or so long even Credit Suisse joined the chorus we started in April of 2009, we are glad to learn that finally, with a ridiculous Rip Van Winklesian delay, but better late than never, "the FBI has teamed up with securities regulators to tackle the potential threat of market manipulation posed by new computer trading methods that have taken operations beyond the scope of traditional policing." In other words, the SEC has finally realized it can no longer pretend it is not co-opted, but because it has no clue where to even start with HFT, has asked the help of the Feds. Which in itself is hardly reason for optimism, but if there is one thing Hans Gruber has taught us, it is that when the Feds get involved, the first thing they do is cut the power, and in this algo-based market that will end some 99% of all daily manipulative practices we have all grown to love and look forward to every single day.
While prosecuting the wrongdoers is clearly not part of the new normal (see Sokol et al.), what Nanex found this morning beggars belief - both in its method of manipulation and clarity that our regulators are clueless. As they note, the high frequency traders (HFT) are at it again. Contorting the spirit of the rules, because those who wrote the rules aren't technically savvy. On January 4, 2013, we found another instance of HFT morphing their manipulative and illegal quote stuffing strategy in an effort to fly under the radar. Why they don't just stop this manipulative practice altogether tells us a few things. First, this isn't some coding error, this is sophisticated cheating. And second, because they are spending valuable programming time on this strategy, there must be some real economic advantage. Which mean a disadvantage to everyone trading against them.
Instead of uttering one more word in a long, seemingly endless tirade that stretches all the way to April 2009, we will this time let such dignified members of the credible, veritable status quo as Credit Suisse, who have released a two part primer on everything HFT related, with an emphasis on the broken market left in the wake of the "high freaks", which is so simple even a member of congress will understand (we would say a member of the SEC, but even at this level of simplicity its comprehension by the rank and file of the SEC is arguable). As Credit Suisse conveniently points out "market manipulation is already banned", but that doesn't mean that there are numerous loophole that HFT can manifest themselves in negative strategies that have virtually the same impact on a two-tiered market (those that have access to HFT and those that do not) as manipulation. Among such strategies are:
- Quote Stuffing: the HFT trader sends huge numbers of orders and cancels
- Layering: multiple, large orders are placed passively with the goal of “pushing” the book away
- Order Book Fade: lightning-fast reactions to news and order book pressure lead to disappearing liquidity
- Momentum ignition: an HFT trader detects a large order targeting a percentage of volume, and front-runs it.
A few days ago, Credit Suisse did something profoundly unexpected: its Trading Strategy team led by Jonathan Tse released a report titled "High Frequency Trading - Measurement, Detection and Response" in which the firm - one of the biggest flow and prop traders by equity volume in both light and dark venues - admitted what Zero Hedge has been alleging for years (and has gotten sick and tired of preaching), and which the regulators have been unable to grasp and comprehend: that high frequency trading is a predatory system which abuses market structure and topology, which virtually constantly engages in such abusive trading practices as the Nanex-branded quote stuffing, as well as layering, spoofing, order book fading, and, last but not least, momentum ignition. While we we cover the full report in the next few days and all its SEC-humiliating implications, it is the last aspect that we wish to focus on because while all the prior ones have been extensively covered on these pages in the past, it is the phenomenon of momentum ignition that goes straight at the dark beating heart of today's zombie markets: momentum, momentum, and more momentum, in which nothing but stop hunts and even more momentum, define the "fair value" of any risk asset - i.e., reflexivity at its absolute worst (in addition to Fed intervention of course), where value is implied by technicals and trading patterns, and where algos buy simply because other algos are buying. Behold robotic stop hunts: HFT-facilitated "Momentum Ignition."
Just in case anyone wanted to know what not to say to defend the absolute horrific mess of self-aware vacuum tubes and errant algos, formerly known as "the market", here is a great primer from Credit Suisse's trading strategist Phil Mackintosh.
Back in the summer of 2010, when the SEC was still desperate to (laughably) scapegoat the May 6 Flash Crash on Waddell and Reed, in an attempt to telegraph to the public that it was in control of the HFT takeover of the stock market (an attempt which has since failed miserably as days in which there are no occult trading phenomena have become the outlier and have resulted in the wholesale dereliction of stock trading by retail investors), we first presented and endorsed the Nanex proposal that the flash crash was an "on demand" (either on purpose or by mistake) event, one which occurred as a result of massive quote stuffing which prevented regular way trading from occuring and resulting in a 1000 DJIA point plunge in minutes (the audio track to which is still a must hear for anyone who harbor any doubt the market is "safe"). It turns out that in the nearly 3 years since that fateful market crash, not only has nothing been done to repair the market (ostensibly broken beyond repair and only another wholesale crash, this time without DKed trades, and bailed out banks, could possible do something to change the status quo) but the Denial of Service (DoS) attacks that HFT algos launch, for whatever reason, have become a daily occurrence as the following demonstrations from Nanex confirm beyond a shadow of a doubt.
Back in 2009 Zero Hedge was first the only, and shortly thereafter, one of very few non-conformist voices objecting to pervasive high frequency trading and other type of quantitative market manipulation in the form of Flash Trading (which has recently reemerged in yet another form of frontrunning known as "Hide not Slide" practices) quote stuffing, and naturally latency arbitrage: one of the most subversive means to rob the less than sophisticated investor blind, due to an illegal coordination between market markers, exchanges and regulators, which effectively encouraged a two-tier market (one for the ultra fast frontrunning professionals, and one for everyone else). A week ago we were amused to see that the SEC charged the NYSE with a wristslap, one for $5 million dollars and where the NYSE naturally neither admitted nor denied guilt, accusing it of doing precisely what we said it, and all others, had been doing for years: namely getting paid by wealthy traders, those using the prop data feed OpenBook Ultra and other paid systems, to create and perpetuate a two-tiered market, all the while the regulator, i.e., the SEC was paid to look the other way. This action was nothing but a desperate, and futile, attempt to regain some investor confidence in the market. It has failed, and since said "enforcement" action has done nothing to restore confidence, expect to see more exchanges slapped with fines for actively perpetuating latency arbitrage opportunities for "some" clients. Well, since the SEC will be desperate to come up with more means of "restoring credibility" of both the market and its regulator, another exchange it may want to look at is the NASDAQ, which as Nanex demonstrates, may well have been engaging in comparable (most likely not pro-bono) latency arbitrage benefiting some: those paying for its direct feed aka TotalView, and thus not harming others, or those relying on the Consolidated Feed (UQDF) for data dissemination.