JPM Explains How HFTs Caused Friday's Sterling Flash Crash

Tyler Durden's picture

On Friday, in the aftermath of the historic pound sterling flash crash, we presented Citi's forensic take of how in just 30 seconds, bid/ask spreads in cable exploded as wide 600 pips.

Today, we provide another take, that of JPM's Nikolaos Panigirtzoglou, who looks at the "gapping market" that emerged on Friday morning Asia time, and shares some color on the role of high frequency traders behind the sudden, dramatic plung in sterling.

Below is his full note:

Friday’s flash crash in sterling reinvigorates the debate about market liquidity and the role of High Frequency Traders (HFTs) as providers of liquidity. Similar to previous flash crashes such as the August 24th 2015 flash crash in US equities or the October 15th 2014 flash crash in USTs, market gapping, a step change in prices from one level to another without much trading in-between, raises questions about market structure and liquidity in FX markets. This is also because FX markets are perceived to be a lot more liquid than equity or bond markets, so the conventional view is that FX markets are unlikely to experience flash crashes or market gapping in the absence of high impact news.

The flash crash in a major currency like sterling questions the above perception and perhaps shows there are liquidity vulnerabilities in FX markets that are more similar to those seen in equity or bond markets. A step change following a significant event such the Brexit referendum or the SNB’s abandonment of its peg is not problematic as it represents a natural market resetting. But a step change triggered by an order flow is more problematic and in our opinion reflective of how vulnerable market liquidity is in FX markets also.

Liquidity vulnerabilities in equity or fixed income markets as a result of changing market structures are well documented. In equity markets the shift away from principal trading towards agency trading, where markets makers simply match buyers with sellers without holding inventory beyond a short period of time, took place well before the Lehman crisis. But the Lehman crisis caused a similar shift within fixed income markets. Regulatory and other forces have made it a lot more costly for traditional dealers to act as principal traders in fixed income markets, inducing them to change towards a more order-driven trading model of matching buyers and sellers with minimal inventory risk, or to retrench and be replaced by agent traders.

At the same time electronic trading and advances in technology has encouraged the emergence of HFTs as liquidity providers in the most liquid segments of equity, FX and to some extent income markets. These HFTs use sophisticated quantitative models coupled with speed and high trading frequency, to exploit small price moves. They do so by arbitraging price differences across venues or by detecting and taking advantage of order shifts or imbalances or by simply exploiting very short term momentum or mean reversion signals.

However, different to traditional market makers, HFTs tend to operate with a much shorter inventory cycle, meaning that they conduct offsetting trades within seconds or even shorter, in order to neutralize  their original position. As a result they tend to quote for smaller sizes and for a very short period of time. This in turn reduces market depth, i.e. the ability to trade in size in markets, especially in those markets where HFTs are important liquidity providers like equity markets. So we note that while the emergence of HFTs has been beneficial for bid ask spreads and small investors, it has likely had a negative impact on the ability of big institutional investors to trade in size. This is one of the reasons big institutional investors have resorted to dark pools for implementing large equity trades.

More importantly, because HFTs’ models are typically adapted to exploit small price moves, HFTs have a higher incentive to withdraw from their market making role in periods when volatility rises abruptly as  they are reluctant to subject themselves to the risk of large price moves. In addition, there is a similar incentive to withdraw from market making when they detect a big order imbalance, i.e. when they detect markets becoming one-sided, as they are reluctant to subject themselves to the risk of not being able to close their position in a very short period of time.

In addition, given HFTs employ similar models, this creates the risk of a simultaneous withdrawal by HFTs in periods of high volatility or stress or in periods when market become more one-sided. A simultaneous withdrawal by HFTs not only amplifies the initial market move, but also creates step changes or gapping markets as liquidity provision gets impaired and quotes are withdrawn.

How big is the role of HFT in FX markets relative to other markets? A previous report by the BIS “Highfrequency trading in the foreign exchange market”, September 2011 concluded that around a quarter to one third of spot FX trading volumes are due to HFTs. But given that this study was conducted five years ago, we suspect that this share has risen since then.

Indeed, the latest 2016 Euromoney FX rankings survey is consistent with a rising share by HFTs as liquidity providers. The biggest change in this year’s rankings has been the advent of non-bank liquidity providers led by XTX Markets who was ranked third for electronic spot FX trading with a market share of more than 10% and third for FX trading platforms. In contrast, the combined market share of the top five global banks dropped to just 44.7% for overall FX trading in this year’s survey. This market share had peaked in 2009 at 61.5% and was above 60% as recently as 2014.

Moreover, many of the banks ranked outside the top 10 for overall FX trading are understood to be sourcing liquidity from non-bank liquidity providers. According to Euromoney, these non-bank liquidity providers or HFTs are set to gain more market share in the future, helped by advances in technology, more defined business models and a lower-cost infrastructure base than traditional FX banks. HFTs are already very important in FX spot markets as mentioned above, but they look to build capability in forwards and other products in the near future.

In all, the FX market appears to be going through structural changes similar to those experienced by equity markets in the past. The advent of non-bank liquidity providers such as HFTs has reduced bid ask spread and increased market efficiency in FX markets, but at the cost of lower market depth and withdrawal of liquidity provision in periods of stress.


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Squid-puppets a-go-go's picture

in other news, China are gutless pussies - shanghai gold matched down to the west rather than maintain the $70 arb


East Indian's picture

They could not resist the temptation of picking a few more tons at a cheaper rate.

It seems the Chinese are determined not to allow anyone to earn by arbitrage between SGE and COMEX. It this arbitrage that will eventually bring down the paper empire of the COMEX. The Chinese apparently do not want this to happen for some more time. They might have an internal target to reach - 20,000 tons, may be - before pulling the plug out of COMEX. If they set the price at 10,000 RMB per ounce, game will be over, I guess.

But, could it be that the actual price without manipulation is impossible to determine as long as these two - SGE and COMEX - exist?

Jack Oliver's picture

China is not only the world's largest gold PRODUCER - It is also the world's largest gold BUYER !!

Why would they want to pay anymore than they have to ???

Muh Raf's picture

This bubble and squeak is so ignorant about the subject matter it's embarrassing. What has HFT ever had to do with liquidity? They were introduced under GWB as a fix for collapsed trading volumes. Now the market actors are so dependent on these algos for the fake volume reports aka "healthy turnover and OI statistics" that it is nigh impossible for the machines to be turned off, leaving the world at the mercy of their 'glitches'.

Yen Cross's picture

  Keep stacking Bitchez.

    Delta, is your friend.

  What ever happened to that pinhead quant at JPM?

ParticularlyStupidHumanoid's picture

If I win the lotto I'm going basically all-in gold. A pinch of silver too, for when you don't want to be flashy.

Blopper's picture

Ways to eliminate dominance AND manipulation of HFTs:

1. Eliminate market fragmentation - consolidate all exchanges into single exchange (with single source of data feed).

2. Eliminate dark pools.

3. Eliminate unfair advantages of HFTs that enables them to front-run, quote-stuff, and layering the market.


Most importantly, eliminating market fragmentation by having just a single exchange will solve most (if not all) the problems today.

Blopper's picture

HFTs are fake market makers.


I have personal experience in this.

I tried to buy the options of an ETF.

The ETF tracks an Asian market, so during the US open, the Asian market is closed, thus the ETF price stays sideway throughout the US open.

I tried to buy the options of this ETF, but failed, because the best offer price moved up one level higher, right after I submitted my marketable order to buy the best offer, turning my marketable order into limit order.

So I canceled my order.

Moments later, the quotes refreshed and the best offer reverts back lower to the previous price.

The HFT fuckers may argue the initial quote I saw was stale, that the higher offer price is the correct one.

If that is the case, then I say FUCK YOU because the ETF was not moving much at all (since the Asian market it tracks was closed) so how come:

1. If the initial price was stale price, then why is there such a thing as stale when the underlying security is NOT even moving?

2. If the initial price was stale price, and the higher offer price is the correct one, then why the FUCK did the quotes get refreshed lower back to initial moments after I canceled my order? Are you sinners telling me the broker quotes me stale prices 2 times? Righttt. If there is a problem, it's other people's fault. You HFTs have no talent in making honest money, that your survival is dependent on good fortune and handouts from the government. Talent and competency-wise, you HFTs have ZERO.

ParticularlyStupidHumanoid's picture

Maybe it's just fraud on the part of the exchange. They bait you with a low price and hope you'll just say "what the hell" and go through with it. If Fry's, an electronics store, knows how to do it, why not a financial system? It's not like the government has the first clue how to audit a digital system.

hedgiex's picture

A reasonable diagnosis of the flash crash. When algos collide in milliseconds, only snake oil peddlers sell you after the fact that they have a system to profit from accidents. What's intersting is that no one is interested in clearing the juices there ? Debris from deformed markets turbo charged by technologies is the new meme for the shamens.

Yen Cross's picture

 Nanex charts are the best Tyler.

 You posted some beautiful articles about HFT, last year. [ some of us read them]

  That's a nice GELMET Hitlery is wearing.  Her wig wouldn't move in a class four hurricane<>

JailBanksters's picture

Go Flash Go

Go Flash Go

Maybe they'll make a Movie

the cork's picture


What a steaming pile of horse chit. The pussies took advantage of the fact Hong Kong was closed. Pure and simple.

The greatest generation is rolling in their grave.

The sins of their sons and daughters are a disgrace to the nation.

Arrest the traitors.


cognitive dissident's picture

Agree cork, but realize that China could have knocked the legs out to purchase more Comex "paper" even cheaper, paper that they may intend to demand delivery on... US bankster thugs or their agents are not the only ones willfully suppressing the price of spot gold after all...

founding fathers are spinning in their graves for sure

almost time to head back to the Temple and turn those tables over again

mosfet's picture

Watch when HFTs start slamming currencies and stocks more often as the algos pick up on increasingly bad headlines...THEN governments will come out denouncing them as destructive and that they need to be outlawed.  Until then, illegally frontrunning equities is perfectly A-OK as long as eveything's going UP.

falak pema's picture

Rumour has it that its Hollande's hard talk on shooting down May and her hard Brexit--said on official media announcement just before the "fat finger" occurred -- which led to the market panic.

I think that is a very flattering view of Hollande's importance to impact the market's movement.

But who knows how irrational the markets can be when a fly can buzz into the American slugfest soup!

Jack Oliver's picture

Flight to the US dollar is the 'intended' consequence - NEXT !!

highwaytoserfdom's picture


second the Bullshit 


Terrorist attack by AlanBenFellon and the 3% primary dealer reserves cabal.  Stealing and raping Mrs. Watanabe with ABE ETF buying among others.  All when biggest lender is out slaming on Asian open.    FED IMF uhuge issue. 

DjangoCat's picture

So who slammed the pound?  Lack of liquidity doesn't cut it with me.