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BIS on FX HFT – “No Problem”

Bruce Krasting's picture




 

There was a time that I hired a good number of FX and options traders. I was good at spotting those who had the “right stuff”.

This was not then (nor is it now) a matter of a superior education. Gender was not a big consideration either (I preferred women, as the macho, big balls thing gets in the way). I never found that a person with an economics major had an edge. The fact is that the rational thinking behind economics has little to do with the day-to-day functioning of markets.

I looked for decisiveness. I would ask stupid questions in the middle of an interview:

What’s your favorite color?


Do you eat Jell-O?

Do you like jazz?

If anyone answered theses types of questions with these; they didn't get a job:

Well, I have several colors that I like. Or;


Err, sometimes I eat Jell-O, but only when I’m sick. Or;


Yes, sometimes I like jazz, but I prefer rock and roll.

The “correct” answers are, Red, No, and Yes. It was irrelevant whether they actually liked Jell-O, but, they had to have an immediate black or white response to a black and white question.

To be effective as a trader required the capacity to make near immediate responses to questions. An FX trader who has to think a few minutes to sort out facts and new information was never going to survive. The ability to immediately answer the question: “Sell or Buy?” was a key factor in my hires.

Now jump forward 20 years and consider the role of HFT trading in FX. What I thought was a critical variable (speed of decision making) has been brought to a level that I never considered possible. This from a BIS report on FX HFT yesterday:

HFT participants in FX can operate with latency of less than one millisecond, compared with 10–30 milliseconds for most upper-tier non-HFT participants (for comparison, it is said to take around 150 milliseconds for a human being to blink).

The robots that are making FX prices are doing so a rate 150 times faster than the blink of an eye. When hiring “real” people I was looking for fast (2-second) Yes or No answers. Computers are now doing it 2,000Xs faster than that. While that should not really be a surprise given what we know about HFT trading for stocks, this information still blew me away.

The conclusions of the BIS report are similar to the thinking regarding HFT and its role in the stock markets:

HFT helps to distribute liquidity across the decentralised market, improving efficiency, and has narrowed spreads.

The study concluded that of the $4 Trillion of daily FX turnover machines are now executing approximately $1 trillion. That’s a hell of a lot of money.

The study does point out the obvious flaw in HFT participation in the FX market:

HFT market-makers have no binding obligation to stay in the market and place quotes in an adverse market environment.

Two examples were provided to back up this observation. The first, a flash crash of the EURUSD on May 6, 2011 the second, the flash crash of USDYEN on March 5, 2011. The results are pretty clear. When times get tough in the FX market, the robots that were “supposed” to be providing the liquidity went on a coffee break. The additional conclusion was that very high levels of HFT trading preceding the crash contributed to volatility. They used this chart to make the point.

The BIS concludes that HFT is not a big concern for the FX market:

There are key differences in market structure that may make a flash crash-type event less likely in FX than in equities

Less likely? What does that mean? The report points to two flash crashes in FX in 2011 (and it’s only September).


I think the study was built on a false premise. The BIS thinks that the May 6, 2011 flash crash in the US stock market was the result of Waddel & Reed. This has been discussed many times before. This is the conclusion of the SEC. I think it’s totally false.  BIS states:

In general, systemic risk is perhaps more likely to be triggered by a “rogue” algorithmic trade than by pure HFT activity.

This is certainly consistent with the emerging evidence about the 6 May flash crash in US equities, which seems to have stemmed from a large sell order executed through an algorithm.

If you start with the assumption that the BIS study is flawed (by virtue of the incorrect conclusion that Waddell&Reed was the cause of the crash) then you have to also assume that the BIS is incorrect on their conclusion that FX HFT is benign.

That’s my conclusion. I think HFT adds to instability. If I’m right, we're going to see more “Pocket Drops” in FX markets in the months to come. There is no mechanism to DK trades in the FX market (as has been done over at the NYSE). One day some big player is going to get conked on the head in a matter of milliseconds.

HFT (FX or stocks) exists for one reason. It’s profitable business. What benefits it may bring for narrowing spreads and increasing liquidity in normal times is far outweighed by the fact that it's also the cause of/contributor to instability when the going gets rough.

There is every reason to believe that some “rough going” is ahead of us. I’m looking for big spikes in FX Vol. With that will come some big name casualties.

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Thu, 09/29/2011 - 17:41 | 1723907 Mediocritas
Mediocritas's picture

The "aha" moment for me was when Island ECN came into existence, and my suspicions were confirmed after decimalization arrived: the bots were about to take over. In equities, the subsequent capture of trading share has been spectacular and relentless, and the same thing is happening to forex.

The BIS is kidding itself. Before too long we're going to see 30%, 40%, 50%, 60% then 70% HFT activity in forex markets, just like we did in equities and, just like equities, the loss of human intelligence directly behind trades is going to lead to the same moronic, correlated, mass migrations during calm periods punctuated by appalling vacuums of liquidity as the bots get switched off at times where brains are needed.

Unlike equities, this isn't mildly amusing. Forex impacts international trade and when you mess with that, you mess with the world economy in a big way. A great way to kill trade is to promote mayhem in the relative valuations of currencies used to make trade liquid and if we've learned ANYTHING from equities, it's that HFT does a great job of promoting mayhem. I'm not talking about day to day general volatility which is bad enough, I'm talking about that huge erosion in confidence caused by events like the Flash Crash.

When a trading counterparty has doubts about exchanging goods for a specific currency due to volatility of that currency (specifically, the risk of taking a massive ass-clenching loss in a "Flash Crash" moment", then real trades don't happen. Real trades, you know, the kind where something actually gets loaded onto a boat with intent to deliver and be used, the kind that are worth infinitely more than the combined "liquidity providing" (bullshit) intraday flipping of bots making "trades".

The people at the top are either absolutely clueless, or they're the ones winning from this. We already got a taste of what's to come in the Flash Crash. Everything tanked simultaneously, all over the world, not just US equities. The nerds have algorithmically linked everything and ultimately where we end up here is the point where everything tracks everything and we might as well just not bother anymore. Just have a single ETF to represent the entire world economy. Buy or sell. It pretty much functions that way now within the sphere of America.

I'm not joking. That's where this eventually leads. Sacrificing everything that makes markets actually useful in exchange for "simplicity". Real trade being replaced by pseudo-trade, the big loser being the real world.

Thu, 09/29/2011 - 17:51 | 1723965 Mediocritas
Mediocritas's picture

I'll further add that where this vector points is a world in which nations have no choice but to protect their economies by eliminating free-floating currencies. I'm calling it. Dominance of bots in forex eventually takes us to protectionism, currency pegs / wars, erosion of trade, imploding economies and rising social instability.

It's obvious, but the dinosaurs in the upper echelons are a few tech-generations out of touch.

Thu, 09/29/2011 - 21:54 | 1724562 Thunder_Downunder
Thunder_Downunder's picture

I dunno mate, as an private FX trader 'flash crashes' have been a part of life for quite some time... only it's usually government intervention that causes it. 

 

When Japan, US or Europe intervene to 'correct a mis-pricing' in one of their asset markets, as one of them seems to do every 4-6months, it cascades across all of the pairs nearly instantly. Take the CHF peg as just one (extreme) example.

 

IMO, FX is a transmission mechanism, so greater vol. in other classes will lead to greater vol in FX. I think HFT in FX may exaggerate existing vol. but I don't think it will lead it. I am more concerned with the impact of HFT on the smaller 'absolute value' markets (like equities).

 

A bigger problem is competitive devaluation. Seems to me that if pegs were to be instated, it would be more likely that smaller trade partners of the majors would do it to protect themselves from reckless policy of foriegn powers. "You want my dirt, you pay my price. No shiny beads accepted."

Wed, 09/28/2011 - 21:11 | 1720424 RoRoTrader
RoRoTrader's picture

Is it just my imagination or is your work getting way more cutting edge?........B and W.......My answer is you have been holding out on us BK.

On the psychology of trading; trading is torture and my best take is it is a business of managing mistakes profitably, not to mention the morality of buying OIL over spec of a war or getting long AUD/JPY as the BOJ floods the market with YEN post a natural disaster that literally swept people lives away.(did the trade and did get heartbreak letters from Japanese friends)

Lots of dimensions to weigh and ponder while the rule is 'survivor'.......kind of like the dork that was put up the other night as a 'trader' and the vid went viral and it turns up on CNN and BBC..........i watched that on a quck pass and 1st impression WAS THIS ASSHOLE IS NOT A TRADER (did not have the lexus).

Best thing i can put up is this; Get over it (profits or losses - my uncle who fought in Korea at Kap Yong gave me that lesson about the human mind tending to forget the horrors and remember the better moments/days), and...... Next........Not in BK's league either, but can still think albeit slower than most.

Not at all convinced there is the BIG selloff coming........maybe some nice range trading while the puppet masters work a revised theatre.

Wed, 09/28/2011 - 16:39 | 1719610 Soul Train
Soul Train's picture

Daddy, what do you do at work?

Answer: I stare at a bunch of squiggly SMA lines, red number lights and green lights, and make quick bold decisions like buy and sell. I am the master of momentum and diversion analysis and can forecast the future based on my unique skill sets and superiority. I prove it based on my making more money than the other guy.

OK Daddy, but what do you actually do?

Answer: I push keyboard buttons.

Wed, 09/28/2011 - 16:28 | 1719581 duckhook
duckhook's picture

Tobin tax of 1/20 of 1% would raise a little money and eliminate the HFT traders.Has to be  universally applied,so that is the hard part..Funny how  10 years ago the markets functiioned ok and with probably less volatility and the hft problem did not exist.The money that the HFT algos are making are coming directly out the hide of hedg funds,mutual funds and other traders.

 

Wed, 09/28/2011 - 16:02 | 1719509 HarrisonBergeron
HarrisonBergeron's picture

Love your stuff Bruce, but the Flash crash was last year. I still think having the machines just switch off in these circumstance is going to dump not gasoline but xylene on the fire. As Michael Milken(?) said "Liquidity is always there when you don't need it"

 

Wed, 09/28/2011 - 14:49 | 1719255 the grateful un...
the grateful unemployed's picture

i worry that too much volatility in the currency trade will someday cause the settlement banks to throw up their hands and say no mas'

Wed, 09/28/2011 - 14:33 | 1719177 cramers_tears
cramers_tears's picture

It's all a crock of shit.  Dimon-Blankfein are doing us all such a big favor by "providing liquidity" and being "market makers."  Just a BIG CROCK OF STEAMING SHIT!  I keep having dreams of a new US exchange named NOHA (No HFT's Allowed).  JPM, GS, BAC, MS can call their friggin' orders down to the pits just like all the rest of us.

As for a solution - just don't play.  Unless you've got good intel on how they're going to cheat and what the fraud-du-jour will yield for your trade.  I was talking to a former risk analyst with Marsh... he is now consulting solely on fraud risk.  He told me, "I'm in the bizness of fraud... and cousin, bizness is a boomin'"

Wed, 09/28/2011 - 14:14 | 1719101 bankruptcylawyer
bankruptcylawyer's picture

bruce man, this was a pointless article, that's the subtext of what most of the above comments are pointing out . 

 

i've seen on the talking heads and ted kaufman and others talk about HFT. 

the issue is DEAD. HFT is simply corrupt and it is simply going to be part of this broken system until the system is completey rolled in a big collapse. that's how it is. move on.

Wed, 09/28/2011 - 14:02 | 1719047 vegas
vegas's picture

First of all, anything the BIS says is nothing more than political elite Bullshit.

Second, if volatility gets any higher in FX I don't know how it does anybody any good, regardless their trading size or what kind of trader they are. Robot trading strategies will get blasted just like everybody else.

Third, when did it become my obligation to provide liquidity and make a market? This is business school bullshit.

But Bruce, I like your observations about traders needing to be decisive.

Wed, 09/28/2011 - 13:39 | 1718942 Executioner
Executioner's picture

 

 It's just me, or it peaked DURING the crash?

 

Wed, 09/28/2011 - 13:37 | 1718941 Bansters-in-my-...
Bansters-in-my- feces's picture

BIS....

Are they not just another "Den of Vippers".

If thier lips are moving thier lying.

Wed, 09/28/2011 - 13:28 | 1718904 sharkbait
sharkbait's picture

Bruce,  great stuff as always.  Problem is how do we avoid throwing out the baby with the bath water?

Applying machines to the process of "making" prices is a great benefit to market liquidity.  I love being able to get a price on any listed option that I want at any time.  Without machines to make those prices I believe the options market would be much shallower with implications for the underlying as well.

Using machines to 'take' prices is where the trouble starts.  HFT algos, that use market orders are the real culprits in my opinion.  They suck liquidity out of the market and are the source of flash crashes.

Is it realistic to limit algos to using limit orders only?  So they would always be adding depth to the market rather than using up available liquidity.

BTW:  Former trading manager myself.  Great questions.  Green, rarely, and no are my answers.  Try adding this one to your arsenal "What is the square root of 4000?"  Wonderful for separating the people with true quantitive skills from the wannabe's.  The goal isn't to get the right answer ( no one will ever get it exactly right) but to see how they are wrong and how quickly they realize it. 

Wed, 09/28/2011 - 13:03 | 1718846 jbeyer
jbeyer's picture

And when did human market makers in the FX market ever have an obligation to post quotes?  Please enlighten me.

Wed, 09/28/2011 - 13:22 | 1718888 newbee
newbee's picture

I don't think it's about "forcing" someone to post quotes.  Obviously no one's going for that.  It's the instability these stampeding elephants now have on the market and their power to make or break the market almost at will.  It's too much power like a loose cannon on a ship deck with the fuse lit.  A monkey with a pistol.  Know what I mean??

Wed, 09/28/2011 - 14:29 | 1719161 jbeyer
jbeyer's picture

A huge emphasis of this post is that they don't have obligations to make a market.  And as I point out, human market makers have never had obligations either.  So he's creating a straw man to knock down. Her's arguing that they increase volatility from their erratic presence, not from the orders that they place. I quote from the post:

HFT market-makers have no binding obligation to stay in the market and place quotes in an adverse market environment. Two examples were provided to back up this observation. The first, a flash crash of the EURUSD on May 6, 2011 the second, the flash crash of USDYEN on March 5, 2011. The results are pretty clear. When times get tough in the FX market, the robots that were “supposed” to be providing the liquidity went on a coffee break. The additional conclusion was that very high levels of HFT trading preceding the crash contributed to volatility. They used this chart to make the point.

Wed, 09/28/2011 - 13:03 | 1718844 Ned Zeppelin
Ned Zeppelin's picture

The easy answer:  ban HFT. Period.

Wed, 09/28/2011 - 12:51 | 1718803 Dingleberry
Dingleberry's picture

Here is ALL you need to know about these markets, incl. stock and forex:

 

They are FRONT RUN thru HFT

The are QUOTE STUFFED thru HFT

They are FAKE (flash) TRADED thru HFT

They are DAISY CHAINED (i.e. reverse trades) thru HFT

They are NAKED SHORT thru HFT

There is no more "old school" liquidity.  Now all we have are thoroughly rigged markets, false participation, failed REAL bids, and on top of that you have a massively increased amount of central bank intervention over the last few years, and it is INCREASING in breadth, depth and frequency. Looks like an wobbling (but still barely orbiting) satellite about to go out of control.  And the SEC is still watching porn....

Wed, 09/28/2011 - 12:57 | 1718825 iDealMeat
iDealMeat's picture

Those people down on occupy wall st. should just start turning shit off.. For that matter everyone should just start turning shit off.. Go to the basement or behind some buildings and start flipping some breakers off..

The servers running the HFT's, DOWN.. Servers running the banker bonus databases.. down... poof gone.. MSM's ability to broadcast BS.. down..

Ben's ability to create some digital QE.. down..

Your digital debt record.. down.... poof gone..

Wed, 09/28/2011 - 12:35 | 1718757 newbee
newbee's picture

Mr. Krasting you astound me.  Of all the various posts on ZH concerning HFT issues, your post here brings into focus the key issues like no one else I've read with the bizzare charts smeared with dizzying colors without ever conveying to the reader what exactly the charts are supposed to mean.  I was unaware that the algos withdrew from the markets during flash events, but were in hot pursuit moments before their "bait and switch".  Excellent!  I think I'm starting to "get it", but just a little bit.  Thanks once again for your enlightening viewpoints.

Wed, 09/28/2011 - 12:31 | 1718739 XitSam
XitSam's picture

... then you have to also assume that the BIS is incorrect on their conclusion that FX HFT is benign.

No. The conclusion could be correct, even though the reasoning was wrong. I believe the study and conclusion was flawed. But Bruce's if/then is not valid. 

Wed, 09/28/2011 - 12:27 | 1718723 NotApplicable
NotApplicable's picture

Bruce, arguing with opinions designed to generate plausible deniability only lends credence that they are opinions worthy of rebuttal.

Why not just claim that the BIS is nothing but BS? All you're doing by playing their word games is creating grounds for further distortion if they decide to make a counter rebuttal. In other words, stop legitimizing them as a distributor of ideas. They are nothing but sophists, seeking to undermine rational discussion with their garbage. Your critique of their storyline is no different than someone who believes the storylines of "professional" wrestling. It's a false premise tp begin with, so there is no value in analyzing it.

Simply put, don't feed the trolls!

 

Thu, 09/29/2011 - 08:09 | 1721420 Overflow-admin
Overflow-admin's picture

"Simply put, don't feed the trolls!"

I never tought I was gonna think about Socrates like a troll basher but I can accept the idea ;)

Wed, 09/28/2011 - 12:26 | 1718713 The Big Ching-aso
The Big Ching-aso's picture

Algos as in......

"We must crash the market to save it."   (?)

Wed, 09/28/2011 - 12:11 | 1718659 earnyermoney
earnyermoney's picture

"The “correct” answers are, Red, No, and Yes."

 

Hilarious. Those were my answers to your questions as I read the post.

As to the danger of HFT in the currency markets, spot on. Weaponized algorithms from Russia/China bring new meaning to "currency wars".

Wed, 09/28/2011 - 12:37 | 1718763 NotApplicable
NotApplicable's picture

Mine were "idiot," "WTF?" and "I'm outta here."

I spent too many years in the USMC to put up with bosses that played mind games (because they were too stupid to do anything successfully but enjoy their power over others). While I understand Bruce's logic behind his questioning, from the perspective of a potential employee, it presents the picture of a dysfunctional office environment. But, given the mindset of traders, perhaps that's the only kind of office that can exist in a Keynesian world where debt is wealth.

Wed, 09/28/2011 - 13:08 | 1718855 earnyermoney
earnyermoney's picture

"I spent too many years in the USMC to put up with bosses that played mind games (because they were too stupid to do anything successfully but enjoy their power over others)"

 

Fits the profile of a pyschopath? Bruce alluded to a study earlier this week on "traders" being worse than pyschopaths. Not surprising, given the "Streets" role in the financial destruction of the past 2 - 3 decads.

Wed, 09/28/2011 - 12:11 | 1718658 Quinvarius
Quinvarius's picture

It still amazes me that anyone would bother trading FX.  I read stuff like this and wonder why this guy is stuck trying to solve an unsolveable problem.

FX has nothing to do with following trade flows anymore.  It used to try and influence trade flows.  Why would you even pretend that there is any way to get an edge in a highly leveraged market that is completely rigged by central banks?  You cannot know what will happen in FX no matter what happens in real life. 

90% of staying out of trouble is avoiding situations.  I advise you find a new line of work.

Wed, 09/28/2011 - 12:51 | 1718802 Bruce Krasting
Bruce Krasting's picture

Currencies are still the ultimate store of wealth. The lead markets not lag them.

If you think you can invest with success and not keep an eye on FX, your wrong.

Wed, 09/28/2011 - 17:09 | 1719773 ConfederateH
ConfederateH's picture

My impression is that the vast majority of people have neither the time or intellegence to "invest with success", most end up getting slaughtered.  Many like me get very frustrated listening to people who assume that everyone should be playing with fx and futures let alone etfs and stocks.  There was a time when we simply could accept real money like gold with a slow and ongoing deflation along with a 2 or 3% real return on paper.  Now slick financial market speculators have made financial speculation a necessity to maintain wealth. 

Thank you Bruce for alerting us to things like HFT latency.

Wed, 09/28/2011 - 12:11 | 1718650 disabledvet
disabledvet's picture

That would go a long way towards explaining the annihilation of privacy through both the entirety of our lives and indeed the entirety of human existence. All "information" would be "necessary" to prevent "us from collapsing your economy." presented in this form of course then the outcome of a total collapse of this system is inevitable since without enforced rules of privacy we cannot conduct any financial activities whatsoever. So sure "hft makes money"...but it has the side effect of "blowing up banking." I think I'd pass myself.

Wed, 09/28/2011 - 11:53 | 1718596 Tic tock
Tic tock's picture

I dunno, the problem mayn't be fx.HFT per se, like. I mean, 'f you're talking about market making responsibilities, or oversight as such, in an HFT world, then the looking gallery has to be at least around as fast as the game - and that we don't have.

Wed, 09/28/2011 - 12:14 | 1718666 disabledvet
disabledvet's picture

The government doesn't have faster computers than the private sector? Really? "the government turned the Internet off in Egypt." move along Nixon.

Wed, 09/28/2011 - 11:49 | 1718584 LowProfile
LowProfile's picture

Polite request:  If you don't know the answers to these questions, please refrain from drive-by commenting it doesn't help (really it doesn't, there are plenty of other comments for you to get your snark on if you want).

 

My understanding is that the FX market trades in a highly fragmented network of dealers.  Given that HFT for stocks requires server co-location, do we know for sure that HFT is taking place in FX?

If a certain dealer was allowing HFT to be practiced on their server racks, couldn't institutional participants route orders around them?

Knowledgable FX participants please chime in!

Wed, 09/28/2011 - 11:38 | 1718555 prains
prains's picture

 the "rogue" algorithmic trade idea, (not the benign flash crash trade) but the potential for a weaponized algo perfectly timed in concert with "other" events has 

defcon 4 written all over it. not to go all ZH alarmist or anything but the flash crashes almost seem to look like test runs. maybe i should just smoke the hope instead.

Wed, 09/28/2011 - 11:54 | 1718601 DeadFred
DeadFred's picture

Fully agree, just like the fractal algos were beta tested before the August swoon I expect the improved algorithms will not be improved for 'our' benefit.

Wed, 09/28/2011 - 12:17 | 1718673 disabledvet
disabledvet's picture

"must have more data! Must have more data!"

Thu, 09/29/2011 - 00:20 | 1720854 cbxer55
cbxer55's picture

Input! Need input Stephanie!

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