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Fundamentally Flawed Markets & The Grey Area Between Cheating And Edge
Submitted by Ben Hunt via Salient Partners' Epsilon Theory blog,
Always confess to a small crime if you want to hide the big stuff. I remember reading this in a Robert Heinlein sci-fi novel when I was a kid, and it’s stuck with me ever since. Once you start looking for this trope you see it everywhere, and even if it goes a little over the top at times in scripted media (anyone remember the “24” season where Jack Bauer tortures his own brother, who gives up a partial truth to hide their father’s role as an arch-villain of treason?), I’m always on the look-out for it in the Narrative construction of our unscripted investment news media.
The problem in mass Narrative construction is not (or at least is very rarely) an issue of intentional misdirection through selective confession. But you don’t need intentionality for this dynamic to take root and misdirect all the same. Much more commonly, it’s the spreading of an easy to understand revelation of old fashioned greed that generates such a sense of outrage among all of us that regulators and policy makers mobilize to “crack down” on a few obvious bad guys while leaving the underlying flawed system intact. The result is that the flawed system often gets a new lease on life, as both the popular and regulatory attitude becomes “Oh … well, I guess so long as you’re not doing THAT, then I suppose we’ve got nothing to worry about.”
Case in point: the record $20 million fine levied by the SEC last week on ITG for its egregious wrongdoing in management of its trading dark pool. I can say that this was egregious wrongdoing without any fear of contradiction because – in sharp contrast to almost every settlement you’ve ever seen with the SEC, where the defendant “neither admits nor denies” anything – ITG was forced to confess as part of the settlement. You can read the SEC press release here, you can read the Bloomberg take here, and you can read the Wall Street Journal take here and here. As with most things market structure-related, I’ve learned a ton about this case from Sal Arnuk and Joe Saluzzi at Themis Trading, who put out a daily note on market structure that I think is very useful.
What did ITG do? They blatantly traded against the interests of their own clients, by peeking into their order book to buy and sell stock in other venues for their own account a few milliseconds ahead of their client orders. It’s pretty much a textbook case of front running, only in a modern context of dark pools and multiple electronic trading venues. This predatory HFT program traded 1.3 billion shares and (per Arnuk and Saluzzi’s calculations) impacted the pricing and execution of about 130 billion shares by a few pennies per share. That's billion with a B. My favorite factoid from the SEC docs: ITG ranked their clients by how easy they were to trade against, and – surprise! – tried to do more business with the suckers. Oh, and here’s another shocker – the suckers were always the sell-side; ITG would turn off the program when it faced its buy-side clients. To be clear, this wasn't a "rogue" operation at ITG, but something that was explicitly approved by their Board ... twice.
My concern is NOT that what ITG did is rampant in the trading world. I doubt that any other dark pool operator or independent execution trader is cheating their clients in such an overt, really almost caricaturish fashion. My concern is in the grey area between cheating and edge. My concern is that our market structure is fundamentally flawed – or at least contains unanticipated and uncompensated risks – and that an honest discussion of those flaws will be shunted to the side in favor of easy regulatory posturing against those darn evil-doers. My strong hunch is that a regulatory and media focus on obvious front running will lock in the current market structure, although equally bad for investors would be some sort of witch hunt against all dark pools and all electronic trading venues.
Whichever way it goes, though, the ultimate result will be the same – an accelerated victory of the big bank trading groups over the high-tech trading firms for control of market flow data. HFT liquidity providers and quant-oriented execution shops are technology companies disguised as financial intermediaries. They hijacked the market infrastructure in the aftermath of the Great Recession, stealing it away from under the noses of the big financial firms who had come to see control over market structure as their birthright, and they had a good run. But now the big boys want their market infrastructure back, and they’re going to get it.
A lot of HFT critics are crowing over the ITG confession. You see! HFT is front running, plain and simple! Told you! And HFT defenders are largely silent because … well, you can’t defend the indefensible. I’m in the anti-HFT camp (see “The Adaptive Genius of Rigged Markets”), but I’m not crowing. If history is any guide at all, the existence of a clearly identifiable small-v villain will forestall the unmasking of what I believe is a Big Bad … the subterranean influence, bordering on control, of human investment behaviors by firms controlling advanced inference machines (see “Troy Will Burn – the Big Deal about Big Data”). Market infrastructure is only the first battleground in this war, but it’s a critical one. If even more advanced non-human intelligences owned by even more powerful institutions are allowed even more unmonitored and unregulated access to even more massive order books, this first battle is even more lost than it already is. But that’s exactly where I think we’re headed.
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It's an edge until you get caught. Then it's not what you did, but who you know and who you did it to that matters.
Watergate didn't bring down Nixon, lies about it did. The problem now is the big lie is official policy from the top down and Orwell was an optimist......
Strange logic.
If Nixon had told the truth about Watergate, he still would have been forced to resign.
It didn't happen that way, but there was no way out for Nixon.
If he'd of told the truth right off the bat, it could of been spun and minimized. Hiding it and denying it got everybody demanding answers and the political mercenaries a chance to overcome any defense.....
From what I understand and know... he had nothing to do with, he just got into trouble covering it up.
Unlike most Pols that do something bad an lie about it to cover it up.
There is a great book that outlines how that break in decision got made. Psycology of Influence, Robert Cialdini.
SO you never saw the Nixon-David Frost interview where Nixon admits to lying to the people about ending the war and about Watergate and to using his staff to do "small harm" for the "greater good" to his nation.
"As President I believed my office allowed me to define the Nation's best interests even if it meant killing 2 million South Asians and 50000 of our own. We had to show them we meant business, even if we had no business being there; except to fight world communism. I didn't want to go in but once there I didn't want to pull out."
So what lies pulled him down other than his own HISTORICAL and POLITICAL lies which sullied the office and debased the Constitution?
Once I'm in, I don't want to pull out either.
unless you're dreaming of hitlery, that is
He was playing the hand he was dealt, rightly or wrongly, or are blaming him for the Gulf of Tonkin incident and the massive escalation that came afterwards?
That's not a baseball. It's a direct energy weapon...
None of these paltry fines means a thing until some of these corrupt assholes go to fucking prison. What a joke...
True punishment is ONLY for the serfs, of course.
Nobody can front-run a limit order.
Please explain how HFT can ever profit when limit orders are used.
Why aren't people using limit orders? I never buy or sell any other way.
If your answer is, "but I need to buy ten million shares for my trust fund!" ...then seriously, I don't care if the HFTs are "front-running" you. Ring your butler for some tea and calm down.
This is horseshit.
The desk holding your limit order is pretty much GUARANTEED to front run it...as pretty much all orders are principal, now, and very few orders are executed agency. In effect, there being very little difference, if any, between front running (illegal) and acting as a principal (legal).
See this:
https://www.google.com/url?sa=t&rct=j&q=&esrc=s&source=web&cd=1&cad=rja&...
And this:
http://www.nanex.net/aqck2/4599.html
The HFT are almost all co-located and taking advantage of a "second market" provided by the slow SIP. Basically, they give the customer who wants to buy a 0.000001 cent improvement: they sell slightly below NBBO. but they can see that the sip is a cent lower before they do it. So they give you a small amount, buy to cover at what they know is a cent lower, take a penny, and do it many times (office space? :) ). That first pdf/Nanex are great.
I'm no big fan of my trustee
Please explain how HFT can ever profit when limit orders are used.
Sure thing, dumbass. HFT means High-Frequency Trading.
Lyin' and stealin' is always lyin' and stealin'. Call it any number of different names but it's still lyin' and stealin'. Sociopaths will always do that; what I don't understand is why honest folks continue to do business with them. Is stupidity a virus?
Off to the next bag of millions.
Dom Chew, previously Bloomberg, now CNBC looks like a complete idiot with his black dyed hair. What's with these guys? idiots, all of them
As long as SOMEONE is paying for "order flow", then cheating is happening. Such payments are the equivalent of mercaptan – the stuff they put in natural gas to let you know what stinks.
The Blood of Jesus.
There is nothing more powerful than that.
"Out damn spot"! Oxy-clean?
Covered from head to toe.
HFT's the new STD's.
I call it "accounting for cheaters". Or cheating accountants? Or...what's that word? Oh, right, WHITE COLLAR CRIME.
Pays VERY well. Are you not involved yet? Get on board! Your odds of getting caught? Low. Returns? Priceless!
See James Comey or any other State AG if you need hints on how to advance in white collar crime.
Started managing a $1 billion fund in the 1970's. My first order I gave to Goldman to buy 300,000 shares of SX. They front ran me and when proved and confronted they said the clerk made a mistake and put down the wrong symbol from someone elses market order and entered it for SX. Most all of them are whores.
Great lesson to have learned so early.
Today, with the internet, etc. multiple that buy hundreds.
If you are an individual there are multitude of whores front running you. I have also been told that they analyze the good traders and bad, one firm calls it book A and book b. If you are a good trader they front you on the buy side and a bad trader on the sell side or fill your order via shorting.