The reasons for last week's collapse will be probed for a long time, and likely no firm conclusion will ever be derived, because it was caused by a confluence of numerous factors. While there may be immediate causes for the plunge, the one recurring reason for both that crash, and all future ones, will be dominant role played by HFT traders as they now control market structure when they operate, and the massive vacuum left when they decide to simply shut down when things get too heated and there is no regulated liquidity provider backstop. As the New York Times reports yesterday from your typical HFT bucket shop "as the stock market began to plunge in the “flash crash,” someone here walked up to one of those computers and typed the command HF STOP: sell everything, and shutdown." A vivid and brief summary of what we have been warning for over a year. Also, we find out that just like Tradebot, which as "one of the biggest high-frequency traders around, had not had a losing day in four years" that Goldman, and all the other big banks who reported a flawless first quarter, are now nothing but one large HFT prop shop: they push the market higher on no volume, and when the selling in size commences they all just shut down. So much for providing liquidity when it is needed. And as for that 4 year track record... What did Madoff go to jail for again?
From the NYT:
Above the Restoration Hardware in this Jersey Shore town, not far from the Navesink River, lurks a Wall Street giant. Here, inside the humdrum offices of a tiny trading firm called Tradeworx, workers in their 20s and 30s in jeans and T-shirts quietly tend high-speed computers that typically buy and sell 80 million shares a day.
But on the afternoon of May 6, as the stock market began to plunge in the “flash crash,” someone here walked up to one of those computers and typed the command HF STOP: sell everything, and shutdown.
Across the country, several of Tradeworx’s counterparts did the same. In a blink, some of the most powerful players in the stock market today — high-frequency traders — went dark. The result sent chills through the financial world.
After the brief 1,000-point plunge in the stock market that day, the growing role of high-frequency traders in the nation’s financial markets is drawing new scrutiny.
Over the last decade, these high-tech operators have become sort of a shadow Wall Street — from New Jersey to Kansas City, from Texas to Chicago. Depending on whose estimates you believe, high-frequency traders account for 40 to 70 percent of all trading on every stock market in the country. Some of the biggest players trade more than a billion shares a day.
And for the closest rendering of the enlightened gambling that occurs each and every day, now that traditional investing is long-dead, the NYT brings you this. Observe the similarity between Tradebot's trading results and those of of Goldman et al this quarter.
These are short-term bets. Very short. The founder of Tradebot, in Kansas City, Mo., told students in 2008 that his firm typically held stocks for 11 seconds. Tradebot, one of the biggest high-frequency traders around, had not had a losing day in four years, he said.
But some in Washington wonder if ordinary investors will pay a price for this sort of lightning-quick trading. Unlike old-fashioned specialists on the New York Stock Exchange, who are obligated to stay in the market whether it is rising or falling, high-frequency traders can walk away at any time.
While market regulators are still trying to figure out what happened on May 6, the decision of high-frequency traders to withdraw from the marketplace is under examination.
Did their decision create a market vacuum that caused prices to plunge even faster?
“We don’t know, but isn’t that the point? How are we ever going to find out what’s going on with these high-frequency traders?” said Senator Edward E. Kaufman, Democrat of Delaware, who wants the Securities and Exchange Commission to collect more information on high-frequency traders.
The HFT response: more of the same lies we have grown accustomed to reading from the HFT lobby.
“We are not a no-regulation crowd,” said Richard Gorelick, a co-founder of the high-frequency trading firm RGM Advisors in Austin, Tex. “We were all created by good regulation, the regulation that provided for more competition, more transparency and more fairness.”
But critics say the markets have become unfair to investors who cannot invest millions in high-tech computers. The exchanges offer incentives, including rebates, which can add up to meaningful profits for high-volume traders as well.
“The market structure has morphed from one that was equitable and fair to one where those who get the greatest perks, who have the speed, have all of the advantages,” said Sal Arnuk, who runs an equity trading firm in New Jersey.
And let's not forget that old broken record and now completely discredited standby: providing liquidity. Sure, when all the HFTs shut down at the same time as soon as the house of cards mirage is evident for all to see, liquidity is gone faster than any credibility this market may have.
“The benefits of the liquidity that we bring to the markets aren’t theoretical,” said Cameron Smith, the general counsel for high-frequency trading firm Quantlab Financial in Houston. “If you can buy a security with the knowledge that you can resell it later, that creates a lot of confidence in the market.”
The high-frequency club consisting of 100 to 200 firms are scattered far from the canyons of Wall Street. Most use their founders’ money to trade. A handful are run from spare bedrooms, while others, like GetCo in Chicago, have hundreds of employees.
Most of these firms typically hold onto stocks for a few seconds, minutes or hours and usually end the day with little or no position in the market. Their profits come in slivers of a penny, but they can reap those incremental rewards over and over, all day long.
A quick glimpse into the "sophisticated" work that goes into picking winners and losers:
The Tradeworx computers get price quotes from the exchanges, decide how to trade, complete a risk analysis and generate a buy or sell order — in 20 microseconds.
The computers trade in and out of individual stocks, indexes and exchange-traded funds, or E.T.F.’s, all day long. Mr. Narang, for the most part, has no idea which stocks Tradeworx is buying or selling.
Showing a computer chart to a visitor, Mr. Narang zeroes in on one stock that had recently been a winner for the firm. Which stock? Mr. Narang clicks on the chart to bring up the ticker symbol: NETL. What’s that? Mr. Narang clicks a few more times and answers slowly: “NetLogic Microsystems.” He shrugs. “Never heard of it,” he says.
And here is what will happen every single time when panicked volume selling picks up: the liquidity will always disappear, as long as HFT's role in market structure is not curbed and regulated.
Mr. Narang said Tradeworx could not tell whether something was wrong with the data feeds from the exchanges. More important, Mr. Narang worried that if some trades were canceled — as, indeed, many were — Tradeworx might be left holding stocks it did not want.
It's all good as long as the market rises without any participation. 401k holders are happy. However as the market is up on nothing but ultra short-term gambling by firms that have no clue what the stocks they churn daily, the days to the next massive crash are already counting down.