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Are We Heading For Another 1987-Style Crash?

Phoenix Capital Research's picture




 

The big story developing in the US markets regards the sudden crackdown by regulators, most notably the SEC and Justice Department, on High Frequency Trading or HFT.

For well over five years now, certain trading firms have been using high-speed computers to front-run orders from other investors.

In simple terms, the market exchanges, like the NYSE, would let these firms (for a price of course) see when someone put in a market order to buy or sell shares on the market.

The trading firm would then use super fast computer programs to buy or sell shares in front of that order, before turning around and selling the shares to the investor at a slightly higher price. The trading program may only make a $0.01 profit by doing this, but because they were doing it millions of times a day, they were making billions of Dollars per year.

At one point, this practice accounted for as much as 70% of all market volume. Put another way, 70% of all shares being traded on the market were not from investors actually placing buy and sell orders, but from computers front-running investors and each other.

These firms argued that they were providing liquidity to the markets (an outright lie). The reality is that they spent millions of dollars lobbying in Washington DC to make sure that the regulators didn’t crack down on them.

However, it would appear that things have finally hit a boiling point with author Michael Lewis publishing a book exposing HFT as the immoral and illegal activity it is.

Between this, and a number of high profile media appearances, Lewis has finally raised public awareness on the issue of HFT. And the public is not happy about it As a result both the SEC and Justice Department have opened investigations.

As far as stocks are concerned, we’ve seen a sharp drop in the companies that were highly favored by HFT firms.

Amazon, an HFT favorite, has imploded from its highs.

The same goes for Facebook:

This was always the problem with HFT: that these firms were pushing prices higher, through artificial pressure, not real buying power. Now that they’re moving out of the market, we’re seeing the consequences of this.

Indeed, the sharp drop in those companies favored by HFT firms predicted the recent collapse in the NASDAQ index as a whole:

Today, the NASDAQ is resting on its 100-day moving average. As you can see in the above chart, this line has help during every correction since 2013.

IF we see a breakdown here (meaning this line doesn’t hold), then the HFT crackdown could become a very serious issue for the markets. With these programs dominating trading so much, removing them from the market will have serious consequences for prices.

The whole situation is very reminiscent of the computer trading, which led to the 1987 Crash.

Could the markets crash again? We’ll see. But smart investors should be prepared for whatever may come.

This concludes this article, swing by www.gainspainscapital.com for a FREE investment reports outlining how to  Protect Your Portfolio from bear market collapses.

 

Best Regards

 

Phoenix Capital Research

 

 

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Mon, 04/07/2014 - 19:39 | 4634041 ThisIsBob
ThisIsBob's picture

The guys under the Buttonwood Tree got worried when a couple of the traders got one of those new fangled private telegraphs installed in a nearby building and stationed a clerk in a window to make hand signals.

But soon everybody was doing it and electronic trading was born.

Mon, 04/07/2014 - 18:36 | 4633840 disabledvet
disabledvet's picture

"Continental Illinois." That was the collapse of the 80's...along with all the S&L's. That was a real mess that had to get cleaned up after oil prices had tanked to under ten bucks.

So sure...down 22% in two days...but equities still look good to me with "War with Russia" as the prepared backdrop.

Securitized debt still looks like total shit to me...or what I called "the three legs of Hank Paulson's stool", first one being prevent default, second being depression prevention and third "fire up the debt engines" to get credit in the hands of the economy and the growth engine turning again.

Wall Street is well past point three...but the economy sure doesn't look like it's past point two.

A conventional war with the Russians "with craziness in Northeast Asia just in case" would move the needle.

So far though growth has clearly downshifted and the election is only months away.

Mon, 04/07/2014 - 17:52 | 4633668 TrustbutVerify
TrustbutVerify's picture

Some of this article's suggestions statements need to exopunded upon.  The '87 crash was caused by computers? The recent downturns of specific stocks shown are definitely the result of HFT trading?  Looks like Amazon was falling starting January 1.  

Other questions I have have to do with the labeling of the problem.  Is it HFT or front running?  Front running is wrong but, overall, HFT sounds legit.  How much HFT would there be if there was no front running?  Would there be front running if there was no HFT?  Does HFT, in itself, provide liquidity?  How fast can that liquidity dry up if the market falls?  Why is there so much editorial using the term HFT if "front running" is really the problem?  

Mon, 04/07/2014 - 19:33 | 4634027 the grateful un...
the grateful unemployed's picture

no the 87 crash occurred when put sellers took on too much risk. the market started lower and it sucked them down with it. the writer didn't mention that HFTs are able to move the share price of a stock without ever filling one of their bids, the ghost bids drive the price on sheer volume, leaving slower players to actually fill the orders at the artificially leveitated price.

Mon, 04/07/2014 - 17:40 | 4633637 SAT 800
SAT 800's picture

YES. don't you have a harder question?

Mon, 04/07/2014 - 17:16 | 4633558 AdvancingTime
AdvancingTime's picture

If we have a flash crash now they have someone to blame and point to as the markets downfall. This dovetails with my scenario for a market "super crash" and a reasonable map that would arrive at such a situation.Most investors think that even if things go downhill fast that they will be smart enough to get out of the markets. But what if it hits like the flash crash on steroids?

We know that can't happen because circuit breakers have been put in place to arrest panic style moves, but imagine a market that falls, trade is halted, and the market simply does not reopen for days, or even weeks. We have set up a house of cards based on debt and contagion is the cancer eating at the foundation. the article Flash Crash On Steroids can be found below.

 http://brucewilds.blogspot.com/2013/01/flash-crash-on-steroids.html

Mon, 04/07/2014 - 15:37 | 4633234 starman
starman's picture

it will different this time! No?

/sarc

 

Mon, 04/07/2014 - 15:30 | 4633211 GreatUncle
GreatUncle's picture

The system absorbed HFT and it became the norm.

Stopping this and the ecoonomy takes a hammering,

If the volume of HFT > real economy you can never pull just like the QE you cannt remove without a collapse.

Mon, 04/07/2014 - 14:48 | 4633080 cashtoash
cashtoash's picture

I think it will be 2014 type crash

Mon, 04/07/2014 - 13:40 | 4632857 Spanky
Spanky's picture

However, it would appear that things have finally hit a boiling point with author Michael Lewis publishing a book exposing HFT as the immoral and illegal activity it is. -- PCR

(emphasis added)

Altho HFT trading may be considered illegal now, nothing regarding money and markets is immoral... That's just a conceit of the moneylenders to consider debts owed them a moral obligation, and debts owed by them dischargeable by law. The moneychangers have always had the best propaganda.

Mon, 04/07/2014 - 13:29 | 4632819 flacorps
flacorps's picture

HFT is the scapegoat not the cause. The lift has come from the Fed. The Flash Boys have sure enough skimmed, but their antics can't create genuine bids where there are none, or (much less importantly) force anyone to sell their shares.

But when the market goes down, nobody at the Fed wants any fingers pointing back at them.

Mon, 04/07/2014 - 11:43 | 4632445 ebworthen
ebworthen's picture

Two words:  "Circuit Breakers".

On when the markets drop more than 1%, off for FED fueled ramps.

Cotton Candy has more substance than these markets.

Mon, 04/07/2014 - 17:49 | 4633662 eatthebanksters
eatthebanksters's picture

two words:  lamp post....you get the idea...

Mon, 04/07/2014 - 12:33 | 4632622 dracos_ghost
dracos_ghost's picture

Ain't that the truth.

"Cotton Candy has more substance than these markets."

Mon, 04/07/2014 - 11:37 | 4632429 the grateful un...
the grateful unemployed's picture

its not the crash of 87 that worries me, its what they did after the crash, when the presidents working group on the finanical markets walked down to the NYSE and gave them a bucket of money to prop up the stock prices. within a year the market had regained nearly all its losses, and we were off the races, first using emergency measures to repair a broken market, then introducing techniques to prevent a crash (Plunge Protection Team) to the grand climax 2008, when the same emergency measures were repeated on steroids. the next crash won't be allowed to happen in the first place, trades will be cancelled (reason given electronic failure) and the sellers will be liquified, or QE'd for their losing positions, (the Fed has it in their charter to buy any kind of asset) and to satisfy margin calls. to make this palatable they will trot out the boards of the largest public retirement funds, to give it their blessing. the cause of the 87 crash, at least ostensibly, was massive put selling, the sellers were collecting premium on far out of the money puts. when the strikes hit the sellers were broke, (if you have ever tried to sell puts you will realize how much you have to put up, and the hedges were using their assets as a bond, just as they rehypthecate your idle account balances right now) so if you want to see a genuine repeat then peruse the open interest on SP and DOW puts for any unusual blips at far out of the money strikes. i dont think the fed and usg will stand by and let the bid disappear on these things, even if one hand is taking away the bid that the HFT posts (however real it is) government will be the bid in stocks, and the HFT trader, final answer

Mon, 04/07/2014 - 12:18 | 4632570 Battleaxe
Battleaxe's picture

Also (from Wikipedia): "On March 16, 2009, FASB proposed allowing companies to use more leeway in valuing their assets under "mark-to-market" accounting. On April 2, 2009, after a 15-day public comment period and a contentious testimony before the U.S. House Financial Services subcommittee, FASB eased the mark-to-market rules through the release of three FASB Staff Positions (FSPs).[19] Financial institutions are still required by the rules to mark transactions to market prices but more so in a steady market and less so when the market is inactive. To proponents of the rules, this eliminates the unnecessary "positive feedback loop" that can result in a weakened economy.[20]

On April 9, 2009, FASB issued an official update to FAS 157[21] that eases the mark-to-market rules when the market is unsteady or inactive. Early adopters were allowed to apply the ruling as of March 15, 2009, and the rest as of June 15, 2009. It was anticipated that these changes could significantly increase banks' statements of earnings and allow them to defer reporting losses.[22] The changes, however, affected accounting standards applicable to a broad range of derivatives, not just banks holding mortgage-backed securities."

Mon, 04/07/2014 - 13:51 | 4632901 the grateful un...
the grateful unemployed's picture

Hussman makes a grand point of FASB rules which he asserts have more to do with asset reflation than the fed. he wrongly believes the tail the wags the dog, and the Iraq war jump started the presidency of w bush. i want to consider what happens when you orphan stocks, that is the invisible hand places a bid under prices, and there are no buyers, so yes you retain your asset value, but its no longer liquid, (much like most of the real estate market). they can keep amazon stock at $400 but there are no buyers. then what you have to do, if you don't want the gambit to implode on you is to allow the parties holding orphaned securities a way to borrow against their assets (sort of a reverse mortgage for stocks) and this is where loosening FASB rules comes into play, and incidentally why hedge funds and institutions are the only ones who want these stocks, (they have access to complicated debt schemes) while the average investor does not, at least not yet.

there is of course always talk of replacing worthless stocks in 401Ks with low interest government bonds.

Mon, 04/07/2014 - 18:41 | 4633858 Handful of Dust
Handful of Dust's picture

The RE market in Austin and Houston has seriously slowed with many Big Landlords dumping their properties theyheld for 5-8 years. I knowit's bad when I see all sorts of 'incentives' again like big screen Tvs, free vacations, etc if you purchase one of their boxes...oops, I mean houses.

Mon, 04/07/2014 - 11:22 | 4632347 no more banksters
no more banksters's picture

"When money start to spread in the society "above acceptable limits", we create financial crises to take them back. We dictate governments to take measures and apply austerity policies directing money back to us. We keep money valuable to everyone and secure our profits."

http://failedevolution.blogspot.gr/2013/12/an-imaginary-dialogue-between...

Mon, 04/07/2014 - 11:20 | 4632335 Save_America1st
Save_America1st's picture

No, not at all...in fact it will be nothing like 1987, it will be multiples worse than anything we've ever experienced and it will be worse than anything this world can imagine.

Mon, 04/07/2014 - 12:27 | 4632607 OldPhart
OldPhart's picture

In 1987 computers were the equivalent to rowboats.  Today, computers are the equivalent of supersonic ICBM's.  When the inescapable problem appears, all financial life as we know it will be nuked.

Mon, 04/07/2014 - 19:28 | 4634012 the grateful un...
the grateful unemployed's picture

makes me recall one reason GHWB lost the election, he was deemed out of touch when he went into a supermarket and he had never seen a barcode scanner. i think most of use had just bought our first PC, i was running DOS on mine.

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