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How The Fed Almost Admitted HFTs Are Illegal

Tyler Durden's picture




 

Yesterday, in "How High Frequency Traders Broke, And Manipulated, The Treasury Market On October 15, 2014" we showed, with empirical evidence thanks to none other than the joint-staff (the Fed, Treasury, SEC and CFTC), precisely how algos broke the Treasury bond market in the morning of October 15, 2014, and specifically how at 9.34 am a blast of quote stuffing and HFT-generated volume...

 

... sent Treasury prices soaring:

 

... while crashing market depth and killing liquidity.

 

We had, of course, know the why and the whot, and had previously already shown most of the above last year, when we explained the events of October 15 almost verbatim to what the joint-staff report noted yesterday. However while we knew the "strategy" we did not know the HFT manipulative "tactics" or just how the algos traded to crush bond yields in what was nothing but one gargantuan short stop hunt.

Thanks to the report we now also know "how" HFT algos rigged the market. And we quote:

The bulk of self-trading in cash and futures markets was observed among PTFs, perhaps due to the fact that such firms can run multiple separate trading algorithms simultaneously. For instance, one of these algorithms could specialize in placing buy or sell limit orders at the top of the order book while another could specialize in initiating trades given specific conditions in that market, potentially leading one algorithm to end up being matched with another algorithm from the same firm. In addition to PTFs, the cash data also showed a very small amount of selftrading by bank-dealers and hedge funds, some of which are also known to trade algorithmically.

 

During the event window, the data showed that the share of overall transactions resulting from self-trading was substantially higher than average. At the 10-year maturity, it reached 14.9 percent and 11.5 percent for cash and futures, respectively, during the move up in prices in the event window (Figure 3.31). During the retracement, when the price moved back down rapidly, the share of self-trading declined to 1.2 percent and 4.8 percent in cash and futures, respectively. Moreover, the concentration of self-trading volume among PTFs was very high in both markets during the event window. Another aspect of self-trading flows during the event window was its directional nature (Figures 3.32 and 3.33). For example, between 9:33 and 9:39 ET, the cumulative net aggressive buyer- minus seller-initiated self-trade volume increased by around $160 million in the cash 10-year note, accounting for close to one-fifth of the total imbalance between buyer and seller initiated trades observed over that time interval

In other words, HFTs were engaging in millions of "wash trades" in which they bought and sold from themselves at an ever faster pace, which pushed the price higher and ignited other momentum algos.

And that, in a nutshell is what price formation has become: who can "wash trade" the fastest.

But wait a minute, isn't wash trading illegal. Yes it is. Here is the CME confirming just that:

Wash Trades Prohibited

 

No person shall place or accept buy and sell orders in the same product and expiration month, and, for a put or call option, the same strike price, where the person knows or reasonably should know that the purpose of the orders is to avoid taking a bona fide market position exposed to market risk (transactions commonly known or referred to as wash trades or wash sales).  Buy and sell orders for different accounts with common beneficial ownership that are entered with the intent to negate market risk or price competition shall also be deemed to violate the prohibition on wash trades.  Additionally, no person shall knowingly execute or accommodate the execution of such orders by direct or indirect means.

So with wash trades illegal at the CME and all other exchanges, did he authors of the report apply the same logic to the wash trading that they found broke the bond market?

No.

This is how the Fed, Treasury and SEC (with the CFTC too) described the clearly illegal wash trading that moved the world's most "liquid" market (from footnote 28 of the report):

At times, self-trading may reflect unlawful conduct. For example, unlawful self-trades may constitute “wash sales.” In the futures markets, “wash sales” involve a purchase and sale of the same delivery month of the same futures contract at the same or similar price, made without an intent to take a genuine, bona fide position in the market, and instead, are intended to negate risk or price competition. In the securities markets, for example, a “wash trade” is a transaction that does not result in a change of beneficial ownership when there is a fraudulent or manipulative purpose behind the trade. This report is not making any findings on the legality of any self-trading that occurred on the days covered in this analysis.

Wait, so the report admits it was HFTs that sent Treasury prices soaring, it explains how they did it, it even admits they did so via wash trades, and after all that... it washes it hands of any responsibility to reign in the illegal algos because "This report is not making any findings on the legality of any self-trading that occurred on the days covered in this analysis."

Brilliant.

So whose job is it to make "findings on the legality" of the wash trades that broke the treasury market on October 15? And how much do they need to be bribed by the Modern Markets Initiative so they, too, can ignore the corrupt, rigged casino that not just the stock, but the bond market, have now become?

 

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Tue, 07/14/2015 - 15:39 | 6312031 astoriajoe
astoriajoe's picture

waiter? check please.

Tue, 07/14/2015 - 15:57 | 6312136 Hype Alert
Hype Alert's picture

Placing orders you don't intend to execute (pulling the bait before the buyer can take it) is also illegal, but is the core of the HFTs.  Unless running the price up between your OWN ALGO'S is the real secret to who is pretending to run the market up.

Tue, 07/14/2015 - 15:45 | 6312053 Glass Seagull
Glass Seagull's picture

 

 

 

"Self-trading might sometimes be illegal, unless the SEC employees charged with keeping tabs on your self-trading want to work at your fund, then:  "'it's cool, brah.'"

 

 

Tue, 07/14/2015 - 16:41 | 6312451 TimmyB
TimmyB's picture

HFTs are illegal because they violate U.S. Securities laws prohibiting fraud. They violate (a) and (c) below because they are a scheme to defraud by manipulating the price of securities via phony high speed securities bids that are not intended to produce an actual securities transaction.

The fact the government looks the other way on these crimes indicates how corrupt it really is.

"Rule 10b-5: Employment of Manipulative and Deceptive Practices":

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,
(a) To employ any device, scheme, or artifice to defraud,
(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security."

Tue, 07/14/2015 - 15:44 | 6312065 froze25
froze25's picture

It is disgusting.  Why not force all trades when posted to be posted for 2 seconds, or about how long it takes a human to cancel them?  Wouldn't that eliminate the problem?

Tue, 07/14/2015 - 15:47 | 6312076 Glass Seagull
Glass Seagull's picture

 

 

Oh, that's totally do-able, IF you want to go back to $0.10 spreads on all stocks, which apparently no retail investor can afford to do (per HFT lobby propo).

 

 

Tue, 07/14/2015 - 16:36 | 6312415 PirateOfBaltimore
PirateOfBaltimore's picture

If the ask I'm seeing is a spoof, then I can't effectively calculate spread in the first place.

Tue, 07/14/2015 - 15:51 | 6312101 bnbdnb
bnbdnb's picture

People don't believe me that markets move in the margin. You've got enough money/shares, you can move the share in any direction you want.

Tue, 07/14/2015 - 16:22 | 6312104 Henry Rearden
Henry Rearden's picture

I've worked for multiple prop trading/options market making company in chicago.  We use futures to hedge large options orders and send them directly to the market (and occasionally work them at a price).   We would also scalp gamma in futures. 

Execution happens very fast, and if you are working a 2 lot on the offer for gamma, but need to buy a 200 lot to hedge a new options trade, pulling your offer and then buying futures will get you filled at a worse price.   Instead we would just trade with ourselves.

I don't see how something like that could possibly constitute a wash sale because the offer was genuine and so was the buy order.  Sure a 2 lot did, by definition, get washed.  But the 198 lot didn't. 

 

Having competing algorithms that are trading with each other on purpose should be ILLEGAL.  Manipulating the market should be ILLEGAL. 

Having different accounts trading with each other with differnt strategies, under the same capital umbrella, should be 100% LEGAL.  Especially when each trader involved is unique and working for themselves.  I'd imagine this situation happens the most frequently, and is ABSOLUTELY NOT A WASH SALE.

Trading through your bid and offer when you have NEW AND HUGE positions to hedge should be 100% LEGAL.

 

I don't know a regulator could differentiate without looking directly at the trading codes or watching the trader for an entire day, and I don't think they are allowed to do that without a warrant. 

 

I also think a lot of high frequency trading isn't inapropriate at all.  One of the firms I worked for had some amazing futures traders, mostly in the treasuries, who would act as futures market makers and spread their trades off in calanders.  It was all high frequency trading, and honest market making. 

It's the high frequencies that front run orders that are the problem.  Some HFTs legitamtely do provide liquidity, CERAINLY NOT ALL, but some do.  Honest, I've seen them. 

Tue, 07/14/2015 - 15:52 | 6312105 buzzy_the_pirate_dog
buzzy_the_pirate_dog's picture

Huh?  Shit 98% of all the orders are wash, slide or cancel...the whole reason for the exchanges is HFT. And of course .01 spread is really useful for everybody, right?

Tue, 07/14/2015 - 15:56 | 6312130 mojojojo
mojojojo's picture

currency is money and credit is gold and currency is value and gold is barbarous and fed prints gold and dollar is in backwardation. the fed is dumping gold in the comex to suppress the value of currency. people are being paid in gold if they lend their precious fiat to the market

Tue, 07/14/2015 - 16:01 | 6312170 detached.amusement
detached.amusement's picture

and this is why the plug had to be pulled last week

Tue, 07/14/2015 - 16:06 | 6312218 BoPeople
BoPeople's picture

At one time this country had something called the "rule of law". Now we have a privileged criminal class and no rule of law.

Tue, 07/14/2015 - 17:28 | 6312697 bthunder
bthunder's picture

someone has been "wash selling" gold and silver for over 3 years...   legally, of course

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