I feel so much better now:
1. It all started with one little trade … O.K.
2. There are no recommendations to bring confidence back; confidence that will prevent another trillion dollar flash loss and that will rein in HFTs.
3. But, there will be more to come … so final judgement will have to wait.
CME comment: click
Thirty years ago, I thought that I understood generally how the markets worked. I am now convinced that it is way above my ability. I no longer feel comfortable investing in paper assets. Better to have a piece of farmland or a rental property. At least I can put a roof over my head or grow something to eat if all else fails.
I think I preferred the fat thumb excuse, at least I knew that was a lie.
This will not improve peoples opinion of investing in the stock market, it has become too much like a casino with the odds mightily stacked against the small investor, and government interference against losses to the market makers.
Gus, the big problem today is that some markets are no longer run by humans; instead, they are run by computer programs (also known as “HFT” or “algos”). These computer programs worked quite well when they were trading against a bunch of people, but now they are mostly trading against themselves, each trying to scalp a cent or two on a trade, as trading costs (which stopped that kind of frantic trading in the past; you needed at least an 1/8th – 12.5 cents – to make any money after both commissions were factored in.) have essentially disappeared. Add to that the fact that the SEC inexplicably allowed a few select firms a 30 millisecond sneak peek at orders, and the result is the screwy market we get today. And that’s one reason you see people fleeing stocks in the US, despite the rise in the US market over the last few months: they’ve realized the market is rigged against them, and they’re not going to play anymore.
It’s like going to a casino and playing craps; you know the house has a small edge (so long as you steer away from prop bets!), and you hope the dice run your way long enough to make a profit. But if you knew that the house could see how the dice would end up a few milliseconds before you did, and could adjust your bets against you, would you play?
That’s why there has been a run into gold and silver, and now people are so distrustful of the exchanges that there are rumours the ETF for gold (GLD) does not actually have the physical gold to back up its claims (despite announcing huge purchases month after month). As a result, people having been moving into physical metal (coins, wafers, and bars) for security. You might make more money buying wheat, but it’s a lot easier to store gold – a roll of quarter-sized gold coins is worth about $50,000, and it doesn’t sprout or rot.
Given this site’s opinion of the MSM, it is sad that CJunk parrots their sensationalist headlines. The first seven pages of the report are a very readable summary, and the gist of it is absolutely nothing like what CJunk posted.
“One trade”: No. There was one company that wanted to sell four billion dollars worth of futures contracts. There were many orders and trades involved to accomplish that. Moreover, they knew perfectly well selling all that at once would cause problems, so they used an algo to feed it into the market at a reasonable. For a position that size, that would normally take several hours. Instead the algo did it in twenty minutes. The report explains in some detail why the algo misjudged it and how algos in future can avoid the same mistake.
“No recommendations”: No again. The report, and the SEC, believe that circuit breakers are the best answer. It explains why the NYSE circuit breaker was ineffective, and also why the CME circuit break – when it finally kicked in – was effective. It provides recommendations as to how circuit breakers can be improved, e.g., so they kick in across the whole market. And in fact the SEC has already adopted new circuit breaker regulations on a trial basis and companies are already updating their systems because of them.
You may read the report and end up disagreeing with it, but imo it’s well worth the read.
“Given this site’s opinion of the MSM, it is sad that CJunk parrots their sensationalist headlines.”
Beg pardon? Zerohedge is anything but MSM. Since when do you hear anyone in the MSM calling out the SEC for such a whitewash of a report? Since when do you hear the MSM calling out the SEC period? Or investigating HFT? Or the developing stories of mortgage and foreclosure frauds going on with the big banks?
Go check out the Market Ticker’s take on it:
http://market-ticker.org/akcs-www?post=168028
This supposedly “large size” order that the SEC blames for the crash? Volumes that size tend to move in ONE MINUTE at the closing bell. And the SEC thinks moving that same volume in twenty minutes crashed the market?
Or try this investigation, which points the finger squarely at HFT:
http://www.nanex.net/FlashCrashFinal/FlashCrashSummary.html
The solutions, in my opinion, are to turn the clock back to pre-2007 rules; including return of the uptick (could there be a flash crash with uptick in place?) The handful of firms doing HTF have far to much influence IMO, and much of the changes since 2007 were brought in to allow them to turn the markets into one big robot experiment which ended up wiping out hundreds of billions of dollars in a few minutes, much of which was not recovered and which has triggered a flood of capital to leave the equity markets.
The SEC is protecting it’s friends, not the general public, not the international community, and clearly not retail investors, or else it’d simply not allow HFT trading; which, by the way, is a new phenonmenon.
Tens of billions of USD are leaving the market as retail investors and industry withdraw from lack of trust; yet, the SEC insists on allowing the markets to be the playground of HFT and other wreckless almost impossible to regulate practices.
The site, zero-hedge, is a noisy bear blog (not MSM) but that doesn’t prevent it from posting scores of pieces by “industry insiders” and very well placed alalysts from major firms … all expressing deep concern over HFT, black pools, and many manner of practice that is driving money out of the markets. Old timers will, in fact, describe how well circuit breakers worked in the past … all they did was feed panic during massive, but logical, sell offs.
The market is a game; hence fairness and rules are key … but as of now, the SEC has no intention of doing the simple fixes that would turn back the clock a few years and bring much fairness back. The SEC is committed to HFT, hence it will bring tricks and tweaks that will simply be side-stepped by the brainiacs in the HFT and other funds that are at the root of this problem.
As someone in the industry, that’s my humble opinion.
Cjunk-
The HFT “problem” derives from two distinct issues, as I see it.
Firstly, the exchanges have accepted payment from certain entities so as to allow a Cray Micro-type to be installed next to the, for instance, NYSE clearing computer, with a four inch diameter fiber optical “pipe” right into the NYSE base clearing mainframe.
It gets better.
These same few firms, with pre-paid clearance, get to “see” the big orders just before the orders are actually entered into the market.
Anybody want to take a stab at “sub” penny markets being available to the public?
The HFT systems use multiple strategies to capture profits where none thought they existed. An example: An HFT algo cycles bids on the NYSE system to run the same size “bid” order from $0.0001 to $0.0099, 20,000 times a second. Any outside order will distort the cycle being generated and will allow the computer execute an order in front of the incoming order, thereby profiting from the trade they can now “see”.
In the commodity trading pits, this is called “front-running” and comes with a term of three to five years in the Federal Pen.
Not so much for the US equities markets.
The CME’s response is summary enough.
Melinda: Exactly. It gets better though, because the HFTs are at war with each other, so they launch all sort of smoke-screen using tricks like quote stuffing to fool each other. The biggest lie used to allow their existance is that they give the exchanges liquidity … but a large proportion of bids and asks are withdrawn before being executed. NYSE argues that HFTs allow it to keep commissions low … which again, is simple blackmail. NYSE just wants the commissions earned from HFTs.
It’s my belief that HFT adds zero to the market as a whole, and it endangers the entire system by causing billions of spooked dollars to leave the markets.
Of course, it’s not just HFT, but my concern is that the run of capital out of markets and gross distortions HFT brings to the market is good enough reason to axe the practice.
Like I said above, the market is like a game, and that game needs rules that make it fair, otherwise too many players will pick up their marbles and go home. Then what?
CJunk-
We agree, once more.
This will not end well.
And I use Monte Carlo, as well as OR, in my pricing schemes.
The HFT mopes don’t even try.
[but they have bigger “pots”]
… and elbows.
Ian: Those “one trade” headlines have been everywhere – NP, G&M etc. Mea culpa for making the association. I agree ZeroHedge can’t be considered MSM. The quote stuffing analysis was quite interesting. Today’s post unfortunately reads like some kind of Tirade Against the Vast Conspiracy. TFHM (tin foil hat media)?
Personally I would have liked the SEC report to say more about the quote stuffing and NYSE data feed delay theories, i.e., more than just “interesting but secondary”. Maybe I missed it somewhere on page 97.
CJunk: There was talk about bringing back the uptick rule, but for whatever reason the SEC doesn’t seem to like the idea. Instead they are more interested in better circuit breakers. Certainly there are dissenting opinions.
wrt the SEC’s “friends”, there are a variety of entities that lobby the SEC. Plus they are influenced by Congress. And yes, they do want investors, both foreign and domestic, to feel confident in US markets. The process is like making sausage. Very slowly.
The lobbying I’ve seen generally hasn’t been intended to screw retail investors. It’s more that there are different kinds of firms on Wall Street, and all of them want rules that will work to their advantage. Sometimes they’ll even propose rules that would regulate their competitors out of existence. Retail investors enter into it more as a debating point. “My proposal will benefit retail investors because of X, but their proposal …”
HFT has had a huge effect on the markets, and it’s still evolving. There have been advantages to retail (and institutional) investors in terms of smaller spreads and lower fees. So despite problems, even serious ones like the flash crash, it seems HFT will be with us a while. Unless of course Congress, I’m sorry, New World Order, decides to impose a transaction tax.
I hate to be the apologist here for Wall Street, because some very bad things have happened and no doubt will happen in the future. But so much of what’s being written out there is bunk.
Someone-
You beter go look at Ian’s nanex link if you want to get a true grasp of the gaming that HFT actually does. And it adds an upward bias to pricing.
Where are the “stub quote” NBBO issues?
And there’s no “uptick” any more due to HF lobbying in defense of the “true” market, which doesn’t have any such restrictions.
However, it also allows for day trading, from the naked short side, without ever having to make the expensive effort to actually findthe stock to short. And they can hold the position for three days with out shares.
No, the CME response is precisely accurate in it’s approach and is an example of where self-regulation can get it absolutely right, and exposes those exchanges that have forgotten their stewardship of the marketplace.
someone: “smaller spreads and lower fees” … I don’t think that smaller spreads in the big names that HFTers trade in have ever been an issue. Removal of the uptick is clear, HFT can’t short en masse with uptick in place. The only logical reason for removal of the uptick rule was to allow HFT to do its stuff. This was, by the way, a Bush Era stunt. As well, since HFT are out of the market at close, they can naked short all day long and there is no mechanism to prevent it at this point.
I don’t buy the cheap pricing argument. You can accomplish the same thing by limiting the number of exchanges (forcing smaller ones to consolidate) … how many are there now? A dozen … dozens?
Most SEC juniors move into the industry in large firms, you seldom get movement the other way around in the junior ranks. Hence, large firms are seeded with ex-SEC members, especially the brilliant ones. Why would a brilliant junior stick around the SEC when they can make huge cash at Goldman? There is of course no proof of collusion, but I find it hard to believe that firms like Golman, which are loaded up with these ex-SEC types, don’t have enormous pull. Given the small number of HFT firms, it is stunning they have gotten a pass so far. That’s why it’s so suspicious … and the billions fleeing the markets is witness to the distrust out there.
I often wonder what it was like the day of the flash crash for those who didn’t purchase back their stopped out stock. Imagine being a large retail investor, like a doctor, with perhaps a million bucks in equities as part of a balanced portfolio. You are at work and know nothing of the disaster going on.
The flash takes out protective stops and you lose perhaps $100,000 or more. You weren’t sitting there with your finger on the button to re-buy. Perhaps some were 2X ETFs … poof … gone … just like that. Even if your money with a third party, it’s possible that stops took out huge sums. Yet, you come home and stock prices are well above where they got taken out.
The result is that you pull out your remaining cash on the next upturn and Do Not come back. Fear (lack of trust), drives you out. Multiply this by billions of dollars and that’s what you have … all because the SEC won’t, and legislators are too uninformed, to turn the clock back to pre-HFT days. It is no coincidence that money continues to flow out, even while stocks climb.