Guest Post: Deconstructing Algos 3: Quote Stuffing As A Means Of Restoring Arbitrageable Latency; Or Is The CQS TRYING To Crash The Market?

Submitted by The World Complex

Deconstructing Algos 3: Quote Stuffing As A Means Of Restoring Arbitrageable Latency

In a recent article Nanex has shown that quote stuffing can slow down the updating of series of stock prices, bids and asks. The article was less clear about why one might do that. There could be arbitraging opportunities.

One of the first games these clowns got into was latency arbitrage. HFTer offers a number of shares for sale at one price, and at the first sign of interest, pulls all of the offers and resubmits them at a higher price. The latency comes into play because as another player send his orders in to fill HFTer, and these orders all find their ways to the market via differing routes, each of which has a different latency (lag time)--so instead of all arriving at once, they arrive singly, giving HFTer time to pull the rest of his bids.

Early this year, Royal Bank of Canada (RBC) launched a new trading program called Thor, which was designed to avoid latency arbitrage. The gist of the program was that the system would monitor the various latencies to all the different exchanges to which orders would be routed, and artificially delayed the submission along the fastest route so that all the orders would arrive simultaneously on all exchanges. While perfection did not occur, the early claims were that the various latency would me measured in microseconds, which at the time seemed reasonable.

Presumably RBC is not the only player that has developed such software.

Now we hear that orders are being stuffed down different channels at such speeds as to change the latencies. In the Nanex article we see:

Today (June 28, 2011) between 10:35 and 11:17, algorithms running on multiple option exchanges (6 or more), drove excessively high quote rates for SPY options (and 2 or three other symbols that I haven't identified yet).  Fortunately this was a quiet trading period.  A total of about 400,000,000 excessive quotes were generated -- that is, compared and scaled to the previous day. In one 100ms period, 2,000 SPY option contracts had about 16,000 fluttering quotes (some combination of nominal changes in bid, bid size, ask, ask size) resulting in saturating/delaying all SPY options on that line. These events occurred several times per minute during the interval. If these algorithms include more symbols, or if they run again during an active market, we will see severe problems. It is shocking to see this so widely distributed across so many exchanges and contracts simultaneously.

I'm pretty sure this is not intended to be damaging to the market. The fact that it runs for short bursts on limited channels suggests that there is a particular target. A target like Thor.

Saturating the quotes on individual lines will change the time lags (latency factor) during the intervals the quotes are generated. For Thor to work properly, it has to estimate by observation the precise lag between sending an order and having it arrive on each market. Randomly changing the lags for the different lines would confound RBC's (and others) attempts at ensuring all its orders arrive on all markets at the same time.

The quote stuffing in this case is intended to be noise, and its intent is to give the latency arbitrageurs the upper hand, as it is easier to generate an immense amount of random noise than it is to formulate an anticipatory response to it in real (microsecond) time.

The only approach I can see (if this is possible) is some kind of all-or-nothing fill on your orders. So your orders arrive on the different markets at slightly different times, but they aren't triggered until they are all ready and then they trigger at the same time. Of course the arbitrageur is probably also the "market maker" and can see you trying to match up your orders prior to execution, leaving you up shit creek in any case.

I really can't see an argument for these actions providing liquidity.



But wait, there's more.

Once again reverting to Nanex' work we now find that beginning this past Tuesday, the Consolidated Quote System not only did not do anything to moderate the threat of qute stuffing, incidentally one of the laments of the Bank of England itself as was noted previously, but has in effect just given a green light to even more quote stuffing, by increasing the CQS capacity from 750,000 quotes per second to 1million quotes per second across all 12 multicast lines.

An innocent, not very sophisticated observer would put a) and b) together, a) being that the market crashed on May 6 due to excessive quote stuffing and b) being that the capacity for quote stuffing was just raised by a third, and conclude that someone high up is actively doing their best to set the scene for another massive market crash at the touch of a button.

That someone will probably be right.

Below is Nanex' full piece on Equity Quote Saturation:

CQS transmits on 12 multicast lines in order to distribute the processing load. The capacity guidelines, expressed in quotes per second, are as follows:

Capacity (Quotes per Second) per multicast line all 12 multicast lines
Before July 5, 2011 75,000 750,000
Starting July 5, 2011 100,000 1,000,000

The following charts plot each of the 12 individual CQS multicast lines and the total (which is divided by 10 to fit into the same scale) on a 1 millisecond basis.

The first chart shows one micro-burst of activity as it occurred on July 5th, 2011, which is the first day after CQS capacity was increased by 33% to 1 million quotes/second. The second chart shows how this same data might look if we imposed the capacity limits that were in effect prior to this trading day.

As you can see, the delay is significant. If this activity level occurred using the limits that existed on July 1st, the delay would have lasted approximately 200ms. We came up with three possible explanations:

1. July 5th just happened to be 33% more active than any trading day in history.
2. The capacity limits from before July 5th were at least 33% too low.
3. An algo is testing how much more quote noise it needs to generate to cause the same effect as before.

So where does it end? CQS is already planning to increase capacity an additional 25% in October 2011. How long before that limit is hit ? We think it will be hit the very next trading day. If 3 years ago someone told us that equity quote traffic rates for NYSE, AMEX and ARCA issues would exceed 1 Million/second (not even counting Nasdaq stocks), we would have thought the market would have entered the greatest bull or bear market ever known. Instead, you can't even recognize from a 1 minute chart where these bursts of out-of-control quote traffic rates occur. And when they do occur, a significant percentage of those quotes will have already expired before they even leave the exchange network.

At these rates of growth, we will no longer have a diversity of trading participants with accurate market data, and regulators will have no hope of ever piecing together what happened after the next disaster. It took the SEC five months just to assemble equity data to analyse the flash crash. When the next disaster strikes, they will have to contend with 5 to 10 times more data.



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