Yet more dusty footprints of High Frequency Trading's shadow domination of markets emerges, courtesy of Matt Goldstein's latest column "The victims of high-frequency trading." Matt focuses on the blatant example of a self-perpetuating myth, driven exclusively by reinforcing algorithms in the April 27 collapse of Dendreon stock, which dropped by 70% in 70 seconds. Bloomberg did a good summary of the events that cost many DNDN investors hundreds of thousands in losses, and which now, five months after the event, the regulators have still not disclosed any additional data to bring this presumably aberrant event to closure.
More than 3 million Dendreon shares changed hands as the stock fell from $24.25 to as low as $7.50 in 70 seconds, before trading was halted at 1:27 p.m. in New York, according to data compiled by Bloomberg. In the first 20 seconds of the sell-off, more than 260,000 shares were sold at the so-called bid price, or about 60 percent of the total, showing investors were willing to accept almost any offer to unload the stock.
Matt provides a different angle on the story: that from the rightful angle of the primary culprit of this dramatic and exacerbated drop in which market makers were supposed to step in... but did not, because they were simply a bunch of computer programs that had no mandate to provide liquidity.
There has been speculation that short sellers, traders who look to profit from the stock’s plunge, spread a rumor that Dendreon was going to report poor test results for its cancer-fighting drug. Others theorize that a broker incorrectly typed in an outsized sell order, which panicked others in the market.
But no matter what the precipitated the sell-off, it’s likely that high-frequency trading magnified it-given that these automated trading programs control more than half of the daily stock trading in the United States.
Some of the algorithmic programs that drive high-frequency trading desks are designed to spot an unusual trading trend — such as a sudden decline in a stock’s price-and jump on it. Other programs, meanwhile, are written to automatically cancel bids to buy fast-falling stocks in order to minimize losses.
“If an HFT guy steps away from a stock, that can drive it down,” says Joe Saluzzi, a co-founder of Themis Trading in Chatham, NJ and an outspoken critic of superfast computer-trading. “It’s not necessarily the shorts pressing a stock down, it’s also because of bids disappearing.”
It’s all perfectly logical from a trading perspective. But when these two strategies come together, it can create a vacuum-like force that allows a stock to plunge in a short span of time. This is the kind of unintended systemic shock to the markets that has got critics and even some advocates of high-frequency trading nervous.
Goldstein's cautionary conclusion confirms the same concerns that Zero Hedge has been voicing for months about potential risks associated with the reckless (and riskless) propagation of quantitive strategies, which can shut down on a moment's notice, creating one systemic Dendreon repeat for the entire market.
Yet it’s not clear securities regulators are sufficiently worried about the potential systemic risk posed by high-frequency trading. And that should worry everyone.
When regulators talk about high-frequency trading they often focus on seemingly obscure things like whether traders should be able to put their computers close to the stock exchange to maximize trading speed, or buy and sell shares through less-than-transparent “dark pools”. These are all important issues, to be sure.
Yet they pale when compared with the threat of a high-frequency trading program sparking a sudden and inexplicable sell-off in a stock.
That’s why it’s imperative for regulators to come clean with what, if anything, they know about the events that led to the April 28 debacle in Dendreon shares.
It’s been five months since that event, and investors are entitled to answers.