HFT

Yesterday, Reuters ran an article "Traders Manipulating Cheap Stocks" in which it cites Jamil Nazarali, Knight's global head of electronic trading, who basically confirms what we have been saying for as long as we can remember, namely that: "Some traders are manipulating U.S. stocks that are worth less than $1 by taking both sides of trades in order to earn big rebates. It happens for hundreds of millions of shares per day." In other words, HFT algos that do nothing but churn and collect "maker-taker" liquidity rebates, are forcing fake prices in, yes, thousands of names. And what that the self-cannibalization fight between the eletronic traders and the HFT rebate seekers just got very real. But what is much more relevant, as Themis Trading points out in their response to the article, is that this is also true for all of the most liquid names, which as the latest Abel/Noser analysis demonstrates, includes such names as SPY, Apple, Intel and Bank of America. In other words, the market structure established by the exchanges to compete with alternative ECNs has now destroyed the very act of price discovery.

Presenting the chart of AAPL: the stock, which has surged from $240 to $292 in less than a month, has done so without violating the 2std dev upward channel once! In other words, nobody but programs which are designed to trade within the traditional technical upward channel of +/- 2 Std Devs are doing the trading in AAPL. And now that your confidence in a rational, non-binary market has returned, please buy, buy, buy. And pray none of these machines has a short circuit, and/or nobody decides to use the Stuxnet virus on the NYSE.

If you think algos gone wild in stocks is bad, just wait until you see what happens when the same feedback-loop generating robots start frontrunning and churning all cotton, sugar, and other commodity contracts. According to this trader, this has already happened. Next up: plunging liquidity, and surging volatility, just in time for commodity prices to find that extra computerized "oomph" as they explode in expectation of Bernanke's reflation experiment gone wild to blow all fair value concepts to smithereens.

One more man awake to the farce that are stocks. Although this being a man as realistic as David, it is not much of a conversion. We can only hope that by 2099 Mary Schapiro's just as blatantly incompetent successor will finally dare to take on the Wall Street lobby and bring some normalcy to capital market topology, instead of nickel and diming micro prop shops which do nothing worse than what the biggest Supplementary Liquidity Providers do on a daily basis. Speaking of, it has been a while since Irene Aldridge was on CNBC defending the practice of small- and medium-investors scalping.

A day full of disappointing news concludes with the mandatory rampage that is sure to get all investors' confidence back in what is the most broken market ever seen by pretty much anyone. Anything less than a triple digit gain in the Dow and today's ICI outflow may be in the tens of billions. Or else the banks won't lend and the system will collapse. In other news, the US is rumored to be issuing High Yield bonds (at sub 5% rates) with which to fund a couple hundred trillion or so in direct "dividends" to US citizens (only those making under $250,000 and/or belonging to labor unions).

In a landmark development for a return to market integrity, regulators are finally getting serious on this whole "HFT thing" after over a year of disclosures of their illegal and manipulative practices by Zero Hedge. Today, Finra announced it is fining Trillium Brokerage Services, LLC, $1 million for using an illicit high frequency trading strategy. So just what is this illicit high frequency trading strategy, that incidentally is used by the bulk of low latency market quote stuffers, er, participants? "Trillium, through nine proprietary traders, entered numerous layered,
non-bona fide market moving orders to generate selling or buying
interest in specific stocks. By entering the non-bona fide orders, often
in substantial size relative to a stock's overall legitimate pending
order volume, Trillium traders created a false appearance of buy- or
sell-side pressure.... This trading strategy induced other market participants to enter orders
to execute against limit orders previously entered by the Trillium
traders. Once their orders were filled, the Trillium traders would then
immediately cancel orders that had only been designed to create the
false appearance of market activity.... Trillium's traders bought and sold NASDAQ securities in this manner in
over 46,000 instances, resulting in total profits of approximately
$575,000, of which the firm retained over $173,000 and subsequently was
required to disgorge." But. But. But. They just provide liquidity damn it! Plus, just like gold, you can't eat HFT. So Finra is telling us now that HFT has market abusive potential? Egads! Does this mean that that the Goldman announcement from last summer's Aleynikov affair when Goldman lawyer Facciponti said that “The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways”, that he was not merely kidding? Luckily, Goldman will no longer have a HFT division as it is spinning off all of its prop trading. Correct Messers van Praag and Canaday?

As usual, we present visual aids for the learning disabled (i.e., those based at 100 F Street, NE) in their Sisyphean quest of understanding a market structure that is about 20 years ahead of where the SEC currently is. Below, courtesy of William Banzai, is what the regulators would find if they could get their conflicted and confused little hands on a HFT trading terminal.

It appears there is a pretty stark difference of opinions on market structure these days, with an increasingly greater majority seeing High Frequency Trading as the devil incarnate, while the HFT lobby, most typically in the face of one Irene Aldrigde, surprisingly defending the practices of the HFT practitioners. Regardless, today's incremental observation on High Frequency Trading fair market practices comes courtesy of Boris Schlossberg GFT Forex, who in a CNBC interview, discussing the massive surge in FX volume which we highlighted earlier, makes the following relevant observation on HFT: "HFT traders have been incredibly destructive to the equity market because they have essentially been doing nothing but frontrunning and quote stuffing." We wonder if Mary Schapiro was watching this particular interview.

If you poke them enough, it appears they do eventually wake up. After many months of rants by Zero Hedge on both subjects of quote stuffing and sub-pennying, it appears the SEC is finally getting involved. Of course, this being the SEC, which a year after saying it will ban Flash trading, still allows HFT frontrunning as a perfectly acceptable and encouraged practice on such exchanges as DirectEdge (and Nasdaq, although the latter has recently voluntarily recanted from abusing the public's, tee hee, trust in regards to frontrunning), we don't have very high hopes. Nonetheless, the fact that the HFT marauders are finally in the regulator's bullseye, will promptly make such occurrences as daily flash crashes hopefully a thing of the past. In other news, we are happy that the SEC is finally starting to catch up with this thing called "teknoulogee."

Submitted by Themis Trading

Bachus Hensarling Letter to Schapiro, and Our Comments.

This morning we awaken to find the Bachus/Hensarling August 24^th
2010 letter to Mary Schapiro in our inbox, which we include as an
attachment for you to read. Ever since the HFT industry formed their own
lobbying group in Washington DC a few months back, we have expected a
letter like this to surface. We certainly have expected it to surface
given the recent anti-HFT media attention post May 6^th. Please allow us summarize their letter for you. In 2008 markets functioned exceptionally well. High Frequency
Trading is beneficial to all. We all benefit from their liquidity. If it
goes away we will all suffer.  Spreads have never been narrower. Costs
of trading have never been lower. There is no evidence that flash order
types are bad. Don’t make any changes unless you have more data. Turning
back the clock on innovation will do harm. With our bias in mind,
please answer in writing to us by September 10^th, 2010 the following 15 rhetorical questions. Had we told you this letter was written by the HFT lobby, you would
have shrugged while commenting that such drivel is what you would expect
that lobby to say. Perhaps we all should shrug less, and be more
alarmed, that it comes from two congressman up for re-election, and
written on the Committee on Financial Services letterhead. Incidentally,
you can see who contributed to Representative Bachus so far in 2010
here : Open Secrets Bachus, and you can see who contributed to Representative Hensarling so far in 2010 here: Open Secrets Hensarling.

Feel like it is time to spread the market annihilation love courtesy of "any minute now" HFT-induced flash crashes? Have no fear, Bank of America is here. "High-frequency trading in the US and Europe has grabbed most attention in the market, but similar activities are quietly taking off in Asia as well." Thusly begins a pamphlet by BofA/ML's Carrie Cheung which explains the tremendous "advantages" that HFTs offer to any local market. Not mentioned is that these advantages include drastic market destabilization, and that the "attention" is of the "get that thing the hell out of here" variety. At least we get to learn some very useful facts about the proliferation of the little bloodsucking algos in the Pacific rim such as...

Anywhere one turns these days, bashing HFT is the new market normal. Having written 150 articles on the topic, beginning in April 2009, we are happy to have brought the world's attention to this most dangerous of market aberrations. Yet until the SEC finally bans the practices of micro churning, quote stuffing, positive feedback loop chasing, flash trading, subpennying, DMA accessing, and all other aspects conceived merely to provide some market participants with an unfair advantage over everyone else, the fight against HFT must continue. Which is why we draw your attention to two items: the first is a paper by Bluemont Capital "The Marginalizing of the Individual Investor" in which the authors question if HFT has distorted true market valuation (yes) and to what degree. Some relevant soundbites: "Unfortunately, high-frequency trader interaction with computerized algorithms of large-cap financial institutions is providing opportunities for high-speed, virtually undetectable market manipulation", "At a minimum, computerized high-frequency and algorithmic trading are undermining traditional value investing strategies. Short-term liquidity and data movements are distorting information on real business performance", "Essentially, high-frequency trading platforms function as positive feedback loops. Engineers treat positive feedback loops as inherently unstable, as each positive response generates stepped-up repetition of the same actions. Positive feedback loops result in an ever- expanding balloon, but like all balloons, the risk of bursting increases with the balloon’s size", and concludes that the "continuing advances in computerized trading pose challenges for regulators throughout the world—and leave individual investors marginalized... Regulators should not only seek to assure that markets are able to continue to function under stress, but they also need to devise remedial actions that protect individual investors who have fundamentally different objectives from the high-turnover objectives of high frequency traders and computerized algorithms." The other notable item is the appearance of our friends at Nanex on ABC radio over in Australia, where firm founder Eric Hunsader discusses the previously highlighted concepts of latency arbitrage as a potential progenitor to the May 6 crash, as well as possible ways that the NBBO arbitrage could have provided for unfair and illegal mispricing opportunities for a select few.

As readers will recall, yesterday we highlighted the HFT-driven flash crash in Core Molding (CMT) after an algo very obviously went insane and took the stock price to $0.0001 in the span of one second. Today, courtesy of our friends at Nanex, we get a transposition of the events at 14:19 in all their visual glory, together with a succinct explanation of everything that went wrong.

In their Q2 letter to clients, Jeff Silver and Ben Hunt of Iridian Asset Management provide an update of the fund's performance and some notable holdings (long: TOO; short: TXT) but the core of the letter is the recap of the firm's "Hollow Market" theme, this time refocusing on what we have long claimed is the biggest threat to market integrity, High Frequency Trading: "On May 6th we saw the hollow market revealed via the so-called “flash crash”, where liquidity throughout US equity markets vanished in the time it takes to turn off a computer server running a high-frequency trading algorithm. As we wrote to our investors that afternoon, we believe that it was the interaction of trading algorithms, ETF’s, and decentralized venues that created the flash crash." The firm proceeds to highlight the two outcomes of what is now known as the Hollow Market paradigm: i) a constant, non-trivial chance of severe market dislocation (which includes a reference to the seminal paper Is High-Frequency Trading Inducing Changes in Market Microstructure and Dynamics, first posted with comments on Zero Hedge, and ii) the need for a Tobin tax, another topic long endorsed by Zero Hedge as a means of fixing the market. Furthermore, all those still confused by Zero Hedge's fascination with VWAP strategies, can finally sleep well after reading this letter. All in all, a must read analysis for everyone (and even the two employees at the SEC with an IQ greater than single digits), curious as to how screwed up our current market truly is (also, thanks for the shout-out).

We have long claimed that the HFT ploy to stuff quotes in an attempt to game other algorithms in pushing the bid or ask side higher or lower would eventually end in tears either for individual stocks, or for the general market, as was the case on May 6. Well, today we just experienced another mini flash crash, after some algo went apeshit and decided to hit every bid on the way down, all the way to 0.0001 (gotta love that sub penny quoting just above zero). Below we show how this algorithm pushed the stock price of Core Molding from its normal price of $4.12 all the way down to $0.0001 in the span of one second, after an HFT program went ballistic, and would have kept on hitting the subpenny $0.0001 bid in perpetuity. It must have been swell to be a CMT holder: one second your stock is worth $4.12, the next, it is worth $0.0001 (and no, not $0.0000, how else will the computers game the NBBO in subpenny increments).