An HFT-Rigged Market: How A Rogue Algo Destroyed The BATS IPO
Considering the rancorous debate currently going on between Michael Lewis (we will have more to say about it shortly), DirectEdge CEO William O'Brien and IEX employee and latest HFT whistleblower, Brad Katsuyma, on CNBC, we decided that this would be an opportune moment to remind readers how BATS, which currently owns DirectEdge, IPOed, or rather how it failed to IPO, when it crashed and burned in its attempt to go public on March 23, 2012, when a rogue algo destabilized the order book and promptly sent the indicative price from around $16 to 0... in less than a second - perheps the perfect testament to just what HFT really does.... and just so readers have an objective perspective of how "unrigged" the market truly is.
From March 27, 2012:
SkyNet Wars: How A Nasdaq Algo Destroyed BATS
Following the May 2010 flash crash, the investing public hoped that as part of its "exhaustive report", the SEC would find and hold responsible the various components of a broken market structure, be it HFTs, ETFs, stubbing and sub-pennying algorithms, and all the other knowns and unknowns we have covered over the years. Instead, in what would prove to be a move of cataclysmic stupidity (if sadly understandable - the SEC, like everyone else "in charge" is used to dealing with a gullible and simplistic public, which has no access to the real data and analysis, and whose opinion could be easily manipulated, at least until now), the regulator blamed and scapegoated it all on a Waddell and Reed trade (we wonder just what the quid pro quo was to get the asset manager to roll over and take the blame despite protestations to the contrary, at least in the beginning). The result was that the same investing public realized that market structure is so corrupt, and so robotically mutated, there is no place for the small investor in this broken market. Last week's BATS IPO fiasco merely confirmed this. And as usual, BATS (whose chairman Ratterman has just been demoted even as he stays on as CEO) decided to take the "passive voice" approach and blame it all on a faceless, emotionless, motiveless "software glitch". Just like that perfectly innocuous BSOD we have all grown to love and expect any minute. Only it wasn't. To get to the bottom of what really happened, in a world in which the SEC is far more interested in finding the latest discount internet porn stream than actually protecting the small investor, we relied on our friends from Nanex, who have time and again proven to have a far better grasp of what it is that really happens in the market than virtually anyone else. And if Nanex' interpretation of events is correct (spoiler alert - it was not a "software glitch") it takes SkyNet wars from the silver screen and to a trading terminal near you. What happened is that a malicious, 100% intentional Nasdaq algorithm purposefully brought BATS stock to a price of 0.00 within 900 millisecond of the company's break for trading! This is open SkyNet warfare.
The fact that the BATS exchange itself halted just prior to break only facilitated this (and could potentially be a case of malicious sabotage). But one thing is clear - as the data below shows, there is no doubt that an Intermarket Sweep Order originating on the Nasdaq exchange was unleashed to make a mockery out of BATS. It succeeded, and in doing so may have destroyed not only BATS chances for going public, but ultimately ruined the firm's credibility. Who would stand to gain from this? Why exchanges such as Nasdaq and NYSE of course, which already are scrambling for revenue, and in the aftermath of the failed Deutsche Boerse merger, it means that any dirty trick in the book to extend and pretend is now fair game. Such as the algo that crashed BATS.
We fully expect that in keeping with its galactic stupidity of yore, the SEC will do nothing to address this situation which is nothing short of exchange warfare using rogue and malicious algorithms as agents of war. Further, in doing so, it will once more destroy any latent "credibility" that the stock market may have created with the retail investor following the 4 month ridiculous and centrally planned melt up (we doubt there is much faith to lose - as we pointed out last week, Joe Sixpack no longer wishes to be the big boys' patsy). Oh well - if the market and its regulators wish to make "investing" solely a provenance of central banks, ultra fast algorithms, and Primary Dealers, so be it. They can play in their sandbox all they want. Just don't expect the trillions in "money on the sidelines" but mostly in savings accounts, where it may earn 0% interest, but at least it won't be vaporized courtesy of some vacuum tube, to ever come back to stocks. Ever.
As for the forensic reconstruction of what truly happened to BATS, below we provide a spreadsheet (the excel can be downloaded here), of every single trade post the BATS IPO
In Nanex' own words:
Start at line 192 -- these weren't stale quotes from Nasdaq by any means. These were highly accurate and precisely updated quotes from a sophisticated algorithm programmed to take BATS's price to 0. You can see the BATS trades just before the algo on Nasdaq starts up. In other words, after the BATS trades print, everything is fine (except of course for BATS' system). Nasdaq's system is just fine. So is CQS (the SIP). That algo did its job with the precision of a master watch maker.
The data and charts make this abundantly clear. The trade(s) that shut down Apple would be considered stale/bad quotes. But not those 500+ trades on Nasdaq.
It had to be someone who's machines are directly connected to Nasdaq because they used Intermarket Sweep Order orders.
Look at the timing! There are many quotes lasting less than 1/10,000 of a second in there! (10 quotes/millisecond). And note the almost perfect 45 degree line in log-scaled blue line below.
Had to be from same algo. Way too perfect. Way. Too. Perfect.
If BATS' system hadn't failed, this algo would have likely been obscured.
Alas, BATS did fail, and the result was last week's epic embarrassment for BATS which already cost the CEO his chairmanship, and the firm hundreds of millions in fresh equity, but also which destroyed any hope that the retail investor may be coming back to what is now a permanently and terminally broken market.
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And For the chart porn addicts, here is a step by step forensic view from Nanex of how a stock exchange is permanently prevented from going public.
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