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It A "Liquidity Mirage": New York Fed Finally Grasps How Broken The Market Is Due To HFTs
In the aftermath of the October 15th, 2014 Treasury flash crash that was much fake "confusion" among the punditry about what caused the dramatic 20-sigma move in the 10 Year treasury. For us, however, there was no confusion, it was all due to a vicious case of HFT algo quote stuffing - a key component of algos trying to establish whether there are credible size orders to be frontrun - gone horribly wrong.
Several months later, in July, the Joint-Staff Report released by the Treasury, Fed, SEC and CFTC confirmed as much, and even if they didn't explicitly single out HFTs as the culprit for the flash crash (that would mean having to redo the topography of the market, in the process gutting and redoing the entire market structure after tacitly admitting the market is broken), they did very clearly note that it was "self-trading", or quote stuffing, that was responsible for the unprecedented move.
Here are the only two charts that mattered from that report:

As we thoroughly documented back in July, this is what the staff report said: "Given the finite capacity of any matching engine to simultaneously process messages and execute matches between buyers and sellers, extremely high message rates appeared to cause trading platform latency to temporarily jump higher", or as we explained it " a massive burst of quote stuffing (seen with absolute clarity on Figure 3.29 above) in the form of a surge in messages, resulted in a burst of accumulated order latency, which in turn was the catalyst to send the price soaring from 129 to over 130 in the span of 5 minutes, and then sliding back down again once the quote stuffing effect was eliminated."
Which brings us to our conclusion then:
... what is surprising is that unlike the SEC's Flash Crash report which was a travesty and blamed the crash on Waddell and Reed, to be followed by another travesty of a report, one which has sent an innocent trader behind bars, this time HFT is explicitly, if not deliberately, singled out.
Which in our opinion sets the stage. The stage for what? Why blaming the upcoming market crash on HFTs, of course. As Bloomberg commented, these findings "will probably add to regulatory scrutiny of the industry."
The reality is that regulators know very well what is really going on in the markets, and now that HFTs have been exposed as the catalyst for the bond market crash, when the inevitable stock market crash - a crash that will be the result far more of the ruinous decisions of central planners around the globe - it will be the HFTs, pardon, PTFs that will be the first to blame, while the central bankers do their best to quietly slip out to a non-extradition country.
Just look at China: the government is so terrified of losing control over its own stock market bubble and the potential for violent, social conflict that would result, that it will throw everything at the market to support it. In the US, the regulators are already one step ahead: they know a crash is inevitable, and the only thing they need is the scapegoat to blame it on when it all comes crashing down.
Nameless, faceless algos would be just the perfect scapegoat.
Today we are one stop closer to that inevitable moment when the enabled systemic parasite, high frequency trading, which exists solely as a result of the market overhaul allowed in the aftermath of Reg NMS, is rooted out.
In a report authored by NY Fed economists Dobrislav Dobrev and Ernst Schaumburg, we get one step closer to the regulators admitting what we have said since day one: HFT does not provide liquidity (although it does provide a whole lot of liquidity-rebate generating volume), it provides a "liquidity mirage."
In the note the authors roundly crush the biggest, and frequently only, benefit of HFTs as stipulated ad nauseam by its advocates, namely an increase in "market efficiency and pricing developments." The authors note:
"that the (price) efficiency gain comes at the cost of making the real-time assessment of market liquidity across multiple venues more difficult.
* * *
... it has arguably become more challenging for large investors to accurately assess available liquidity based on displayed market depth across venues.
* * *
This situation, which we term the liquidity mirage, arises because market participants respond not only to news about fundamentals but also market activity itself. This can lead to order placement and execution in one market affecting liquidity provision across related markets almost instantly. The modern market structure therefore implicitly involves a trade-off between increased price efficiency and heightened uncertainty about the overall available liquidity in the market."
* * *
The striking cross-market patterns in trading and order book changes
suggest that quote modifications/cancellations by high-frequency market
makers rather than preemptive aggressive trading are an important
contributing factor to the liquidity mirage phenomenon.
Goodbye to "fat fingers" being blamed for flash crashes, and welcome to the Heisenberg uncertainty market: you can have your 1 cent bid/ask spreads... but you can't have any real market depth at the same time.
And the moment you try to buy or sell a big chunk in Treasurys (or any other asset class), that tight bid/ask spread explodes as HFTs yanks opposing offers (or bids), and all the telegraphed market depth evaporates in an instant, leading to events like October 15, 2014.
As Bloomberg summarizes the note, which adds nothing new to what we have said over the past 6 years, "after examining trading across the most active platforms, including futures through CME Group Inc. and cash Treasuries on ICAP Plc’s BrokerTec and Nasdaq OMX Group Inc.’s eSpeed, the researchers found evidence that high-frequency traders create an illusion of liquidity in the Treasuries market."
With their stealth technology, high-frequency traders are able to detect competing investor orders on one of the trading venues, and with a five millisecond delay -- the shortest possible transmission time between the CME and BrokerTec -- they’re able to pre-empt the order that’s likely to appear on the other venue.
Once again: what HFTs do in a normal state is not trading; it's frontrunning and trying to evaluate just how many of the other concurrent "orders" in the market are just as fake; needless to say, the one with the fastest server and most expensive colo box wins, even if they never actually provide liquidity.
Investors often submit orders to buy or sell to all three venues in an effort to get the most competitive prices. The order is likely to reach one of the trading venues first, which gives the high-frequency traders the opportunity to profit from the time lapse.
The moment a real order does enter the marketplace, the quasi equilibrium represented by the order book disappears in an insant leading to the liquidity mirage the NY Fed has exposed.
How did the two authors reach their conclusion, one which has been known to our readers for years?
The researchers pointed out a trade that may be completed by an investor on BrokerTec.
"As soon as the BrokerTec transaction is observed in the market data feed, co-located low-latency market participants may immediately seek to cancel top-of-book offers on eSpeed and CME or submit competing buy orders to eSpeed and CME," researchers Dobrislav Dobrev and Ernst Schaumburg wrote on the N.Y. Fed’s blog. Top-of-book orders reflect the highest buy and the lowest sell prices. Low-latency is another term for the high-speed trading technology.
"The striking cross-market patterns in trading and order-book changes suggest that quote modifications/cancellations by high-frequency market makers, rather than preemptive aggressive trading, are an important contributing factor to the liquidity mirage phenomenon," the researchers wrote.
Worse, the researchers "did not find any evidence that the liquidity mirage was more pronounced on Oct. 15 compared with our control days." In other words, courtesy of HFTs, multiple-sigma events like October 15 are always just around the corner, and always threaten to unleash market chaos the moment some unexpected "shock variable" disturbs the artificial equilibrium created by countless HFT algos to give the impression of an deep, orderly market.
In the aftermath of this report, one can be sure that the days of current market structure are numbered, and that the scene is now set to throw the book at the HFTs. The only thing that is missing is the appropriate catalyst. And what is better than an orchestrated, or ad hoc, market crash, one which exonerates the real culprit for the stock market bubble - the Federal Reserve - and unleashes populist anger by millions of investors who lose their net worth in an HFT instant, aimed squarely at the HFTs, and the 20-year-old math PhDs behind them?
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Is it a rude awakening when you wake up dead?
I'm just not sure.
No, it's only rude to actually think you are alive, but then only to realize that you were actually dead all along...
I see dead people...
Death is a bit like sex... except after death you can't smoke a cigarette.
Obama will not finish his second term! Current Events Linked to Ancient Biblical Prophecy!
http://motivationdose.com/is-america-babylon/
I'm waiting for the day when the "market" flash crashes down to S&P 666 and the close the doors on the casino as a result. People will stare at their screens stupefied murmuring to themselves " but the circuit breakers...."
that won't happen, they will pull the plug long before the circuit breakers, like they test run few months ago. everything just stops and halted.
One acronym...: BATS.
That was before. The Chinese market regulators have since shown the way.
There will be no down-days of note.
Rig rig rig! everything is rigged and everyone is going along with it, nobody cares anymore.
The fact that it is so easy to fix is proof that it is rigged.
How to fix? Never cancel a trade. Ever. For any reason.
Populist Anger?
I thought Fluoride in the water eliminated that.
Besides, there is always football. And fast food. And porn
Lots of us with our own well, no floride for us, just fertalizer runoff. YUM!
So gosh... the tight spreads applauded and advertised all over the place are just an... illusion?! Say it ain't so.
Please do not refer to Mr. Yellen in such uncomplimentary terms.
Calling this rigged is inadequate. Calling it the biggest rip-off in history is a helluva lot more accurate....
Hey, it's not like our a lot of peoples' retirements are dependent on...oh wait....
where do I get my hands on one of these ripoff front running hft programs? Put it in the hands of all "traders" so maybe we can rip off some of these parasite shysters
this idiocy hurts braincells.
there is liquidity, the most of any market in the world. it's just not "liquid" at the fake prices manipulated by the people running the HFT - most of them probably in very high places. they all want prices lower and yields higher, hence yields collapsed that day as the real price is much higher than the criminals want.
in other words, real holders of treasuries will not sell for these fake low prices. without these schemes our yields would be at the very least on par with England, most likely close to France's.
I think they should skin all of those fuckers alive and then hang them on poles on Wall Street to die a slow, public death. You know, just a subtle warning...
Don't you think we should try to save them with exorcism firt?
Isn't exocism where you pour acid on them and hit them with red hot pokers?
Thinking we could use something solid these days ... that would be illiquid in economic terms.
dobrislav and ernst, lulz
They'll just close the markets if it looks too bad.
I wonder if there is some sort of data source that lists HFT players? I feel a web app coming on...
After an excellent summary of the HFT scam, Tyler, in his last sentence, makes the Fed the culprit, as though the Fed invented high frequency trading. Where's the connection?
On the trading floor of an exchange "self trading" would be tantamount to " wash trading " - creating FICTITIOUS volume and thus NOT a true reflection of one of the market's basic raisons d'etre of establishing a valid price through legitimate price discovery. Wash trading would have earned the culprit a quick audience with Compliance personnel. Enough already with this financial legerdemain - Shenanigans was a 1960s kids game show - maybe that's where these HFT assholes got their inspiration.
Imagine a market where you removed HFT, ETFs and options and everyone actually just traded stocks.
something to be said for one little old lady with a clipboard, making a check and asking for a signature.
Question, Do the HFT programs cause the ramps at dayparts like 3:30 and in the mini futures overnight.
it seems the markets follow a timing pattern often. What happens if the HFT programs deciede to short the markets ? Do they play it both ways ?