Trading Systems

• Syrian Rebels Hurt by Delay (WSJ), U.S. seeks quick proof Syria ready to abandon chemical weapons (Reuters)
• Lavrov Brings Acerbic Pragmatism to Syria Meet With Kerry (BBG)
• Five years after Lehman, risk moves into the shadows (Reuters)
• U.S. shares raw intelligence data with Israel, leaked document shows  (LA Times)
• Japan to raise sales tax, launch $50 bln stimulus (AFP) - so 1) lower debt by sales tax, then 2) raise debt through stimulus.
• Blackstone’s Hilton Files for $1.25 Billion U.S. Initial Offer (BBG)
• Second Life Bankers Thrive in Dubai as Boutiques Boost Fees (BBG)
• Brussels probes multinationals’ tax deals (FT)
• Wall Street's Top Cop: SEC Tries to Rebuild Its Reputation (WSJ) ... and fails
• Tablet sales set to overtake PCs (FT)
• The end of angst? Prosperous Germans in no mood for change (Reuters)

• Obamacare, tepid U.S. growth fuel part-time hiring (Reuters)
• Cameron was behind UK attempt to halt Snowden reports (Reuters), Britain defends detention of journalist's partner (Reuters)
• Goldman Options Error Shows Peril Persists One Year After Knight (BBG)
• China expresses 'shock' as Japan's nuclear crisis deepens  (Reuters)
• Inquiry into China insurance firm rattles industry (Caixin)
• Cheaper rivals eat into Apple’s China tablet share (FT)
• Exporting fast food: Subway Targets Europe With as Many as 1,000 New Outlets in 2014 (BBG)
• Reserve Bank of India boosts liquidity to ease pressure on banks (FT)
• Justice Department Plans New Crisis-Related Cases (WSJ) - Holder doing his cutest attempt to pretend the TBTProsecute aren't
• Syrian Opposition Alleges Gas Attack, Which Government Denies (WSJ)

As it turns out, just as we had suspected, the 6% move in the Chinese A-shares index, was nothing more than a CNY7 billion (just over $1 billion) fat finger in the "arbitrage system" of Everbright securities. And just what system is that - if the market is about to sell off do a smash-the-open to kill all downward momentum, and as for the losses from the trade, well there is a PBOC to foot the costs? Also, if all it takes to move a multi-trillion stock market is just a $1 billion "fat finger", imagine what $85 billion per month would do...

When we tapered our coverage of HFT manipulation and stock market abuse some time ago, we thought that the message had been heard loud and clear: high frequency trading is a sophisticated market manipulating parasite, whose only real function is to abuse market structure and integrity, by making conventional market manipulation practices more difficult to spot and identify. It turns out some, i.e., Newedge, thought they could still get away with traditional manipulative practices such as spoofing, layering, momentum ignition, wash trading, bypassing, and others, if only they were wrapped in an HFT blanket. It did so for four years from 2008 until 2011. As it turns out it was wrong, and in a stunning example of actually doing its job, FINRA fined Newedge, which is one of the largest futures brokers in the world and ranks third in terms of U.S. customer assets on deposit, a record $9.5 million.

Congress wanted to know what would happen if such a “glitch” ate a hole in the balance sheet of a Too Big to Fail bank? The answer: yet another round of tax-payer bailouts.

There was more. BATS, Facebook, and Knight were just the three most prominent computer glitches of the year. Outsiders were realizing what the insiders had known for years: The U.S. stock market was plagued with glitches that happened on a daily basis, and not just in stocks. Markets for commodities, bonds, and currencies all had their fair share of computer-driven mishaps. Increasingly, investors were wondering not only if the market was rigged, but whether it was completely broken. Indeed, the trade publication Traders Magazine called 2012 “The Year of the Glitch.”

The market deals extremely poorly with paradigm shifts or cycle changes. One reason for this is that there has been no need for any strategy except for the just-buy-the-dip mantra. This may have ended and that could be the best signal to the markets since the global financial crisis started. Sorry to be the messenger, but the only way for investors to understand risk and leverage is by having them lose money. Essentially then, the balance of this year could be an exercise in re-educating the market to long-lost concepts such as loss, risk, inter-market correlations and price discovery. We even predict that high-frequency trading systems will suffer, as will momentum-based trading and, most interestingly, long-only funds. Why? Because, at the end of the day, they are all built on the same premise: predictable policy actions, financial oppression and no true price discovery. We could be in for a summer of discontent as policy measures and markets return to try to search out a new paradigm. This will be good news for all us.

Moments ago the 101 USDJPY tractor beam was broken, sending the pair lower, as a red headline hit the tape saying that...

• JAPAN TO IMPOSE NEW RULES ON FOREX MARGIN TRADING, NIKKEI SAYS

Which incidentally was long overdue: with the BOJ scrambling to contain bond (and stock, if only to the downside) volatility, it was always the FX market that was the primary uber-levered culprit moving both asset classes. As such, it was very surprising that in a world in which all correlated asset classes (just look at the USDJPY-ES relationship) are driven by FX, that currency leverage and margin rules have remained largely untouched by regulators and central bankers whose credibility is suddenly slipping away, alongside the surge in global market volatility in the past week.

Silver’s recovery yesterday from being 10% lower at one stage to recouping these losses and then rising over 2% was very positive technically. The key reversal is leading some to postulate that we may have seen the bottom or are close to a bottom. 

Below are portions of a comment letter submitted by R.T. Leuchtkafer to the SEC on April 16, 2010, just 3 weeks before flash crash. The second paragraph in the excerpt below, unknowingly describes exactly how the flash crash was started. The letter goes on to alert the SEC on the dangers of High Frequency Trading (HFT), phantom liquidity and other concerns.

• Don't jump to conclusions over general, Pentagon chief says (Reuters)
• Bad times for generals: Pentagon demotes 4-star General Ward (Reuters)
• Investors Pay to Lend Germany Money (WSJ)
• Noda will no longer be watching... watching: Japan PM honors pledge with December 16 vote date, to lose job (Reuters)
• New China leadership takes shape (FT)
• Hispanic Workers Lack Education as Numbers Grow in U.S. (Bloomberg)
• Quest for EU single bank supervisor stumbles (FT)
• Anti-austerity strikes sweep Europe (Reuters)
• Amazon faces new obstacles in fight for holiday dollars (Reuters)
• SEC Expands Knight Probe (WSJ)
• Singapore’s Casinos Lose Luster as Gaming Revenue Decline (Bloomberg)
• Amid Petraeus sex scandal, Air Force to release abuse report (Reuters)
• Geithner’s Money Fund Overhaul Push Sparks New Opposition (Bloomberg)

Life imitates math.

The EU assembly just voted affirmatively to impose a spate of rules to control 'high-frequency-trading that, as the WSJ reports, was advanced by Germany following their concerns that speedy traders have brought instability to markets. It is somehow reassuring that three-years after we first brought HFT to the mainstream's agenda, at least one nation is taking it seriously, doing something about it, instead of being filibustered into the 'liquidity-providing' meme. The rules will initially require registration, collect fees on excessive use of HFT methods, and install circuit breakers with the goals to "limit the risks associated with high-frequency trading" per a senior German FinMin; but the more stringent rules to come will have the greatest impact as they intend to include requirements for orders to rest on the exchange book for at least half-a-second, and potentially order-to-trade ratio caps. Not surprisingly, the HFTs believe a "one-size-fits-all approach would be very harmful." Indeed - to their profits.

Ray Dalio, founder and co-chief investment officer of Bridgewater Associates, L.P. and one of the most successful hedge fund managers of all time told Maria Bartiromo last week that he owns gold and that he sees no “sensible reason not to own gold”. The interview was part of the Council on Foreign Relations (CFR) Corporate Program's CEO Speaker Series, which provides a forum for leading global CEOs to share their priorities and insights before a high-level audience of wealthy and influential CFR members.  The respected hedge fund manager suggested that a depression and not a recession was likely and warned of social unrest and the risk of radical politics as was seen with Hitler and the Nazis in the Depression of the 1930’s. Dalio spoke about how “gold is a currency” and when asked by Bartiromo “do you own gold?”, he smiled and said “Oh yeah, I do.” The admission elicited a laugh from the CFR audience. Dalio’s interview is important as it again indicates how slowly but surely gold is moving from a fringe asset of a few hard money advocates and risk averse individuals to a mainstream asset. Wealthier people and some of the wealthiest and most influential people in the world are slowly realising the importance of gold as financial insurance in an investment portfolio and as money. This will result in sizeable flows into the gold market in the coming months which should push prices above the inflation adjusted high of 1980 - $2,500/oz. The interview section where Dalio is asked about gold by an audience member begins in the 43rd minute and can be seen here.

This month marks the 50th anniversary of Thomas Kuhn’s The Structure of Scientific Revolutions, one of the landmark philosophical texts of the last century.  The central thesis of the book is that science advances in fits and starts, clustered around the advent of new 'Paradigms' - a term that Kuhn introduced in the book and much of academia subsequently coopted as their own.  This was a novel thought for the times, since the conventional philosophy held that science advanced through the ages in plodding but rigorous steps.  Kuhn’s observation about science is equally applicable to capital markets, for the range of 'Paradigm shifts' underway goes a long way to explaining everything from why companies refuse to invest to why earnings multiples on U.S. stocks remain so low.  Today, in celebration of Kuhn's opus, ConvergEx's Nick Colas offers up a list of the 'Top 10 Paradigm Shifts' currently underway; and notes that new paradigms don't often have as much to them as the old ideas they replace.  They are often actually inferior.  Over time they get their bearings, yes.  But the transition is rough.

While the attached interview between the Casey Report and HFT expert Garrett from CalibratedConfidence will not reveal much unknown new to those who have been following the high frequency trading topic ever since ZH made it a mainstream issue in April of 2009, it will serve as a great foundation for all those new to the topic who are looking for an honest, unbiased introduction to what is otherwise a nebulous and complicated matter. We urge everyone who is even remotely interested in market structure, broken markets and the future of trading to read the observations presented below.