In a market where the Virtus of the world have, through outright manipulation, achieved trading perfection, it’s rare than a carbon-based lifeform bests a vacuum tube. Despite the odds, humans have scored two decisive victories YTD over the machines.
One came in mid April when Colorado Springs resident Lucas Hinch took his Dell in the back alley and executed it [13] with a handgun.
The second came later that month when China’s millions of newly-minted ‘investors’ traded so much that they literally overwhelmed [14] the software that tracks volume on the SHCOMP. Here's what Reuters said at the time:
The exchange's trading turnover exceeded 1 trillion yuan ($161.28 billion) for the first time on Monday, but the data could not be properly displayed because its software was not designed to report numbers that high.
[15]
Now, China's legions of day-trading retail investors with be forced to contend with 'slightly' more advanced software because as Reuters reports [16], The Flash Boys are coming:
The rapid liberalisation of Chinese derivatives markets has attracted a new breed of creative traders employing complex trading strategies that can generate quick profits - and an extra dollop of risk - in China's runaway stock boom.
Brokerages and fund managers are investing in mathematics whizzes and hardware, and moving servers onto trading floors to gain precious microseconds dealing in new options and futures contracts, helping China's CSI300 index become the world's most traded equity futures contract in May.
The introduction of new derivative products is intended to help investors hedge risk, but it also gives rise to the kind of sophisticated trading strategies that have made quick-trading "flash boys" notorious in the United States and Europe.
For the most part the strategies and the traders employing them are untested in China, where the derivatives market barely existed five years ago, and slick automated trading strategies can produce horrific crashes when they go wrong.
As we've been at pains to explain for years — and as the rest of the world is slowly realizing on the heels of last October's Treasury flash crash — stop-hunting, hair trigger HFT algos help create the conditions for harrowing bouts of volatility and considering the number of inexperienced (and possibly illiterate [17]) traders that have entered the Chinese equity markets over the past several months, combined with the amount of leverage these traders have employed on the way to driving the SHCOMP to historic highs and pushing valuations on the Shenzhen to a median of 108X, it would seem that adding automated trading to the mix is just about the worst thing that could possibly happen in terms of stability. Here's more from Reuters:
The risk is amplified by a triple-digit percentage leap in the SCI. Chinese bourses have already seen three panics that have driven major indexes down about 6 percent in short order. On Thursday afternoon benchmark indexes suddenly plunged over 5 percent, wiping out 3.4 trillion yuan ($548 billion) of market value, only to turn positive again by the close.
[18]
(Thursday's turbulece visualized)
Analysts blame the new volatility on the preponderance of retail investors in the Chinese market - unlike in the West, where institutions dominate - and to the fact that many Chinese traders are highly leveraged, which tends to amplify movements.
[19]
[20]
("That aint no margin debt, THIS is margin debt")
As for the traders themselves, the opportunity to test can't-lose strategies in the hottest market on the planet is too enticing to resist:
That has already attracted overseas returnees like Wang Feng, a physics graduate from University of Michigan and former Wall Street trader, who finally sees an opportunity to apply scientific methods in China's stock and futures markets.
"Theoretically, we hope to achieve the same speed as in U.S. markets, transactions occurring in microseconds," Wang said.
And for all of China's rabid, day-trading housewives, security guards [21], and banana vendors [22], prepare yourself because the challenge has been issued:
"China's market is highly inefficient, which means it's relatively easy to produce absolute returns," said Ken Zhu, Chairman and CEO of hedge fund firm Scientific Investment. "Chinese retail investors don't have any advantage over us."
