Via a registered investment advisor, who explains; You will want to read this, which explains exactly [the flash crash] a year ago May 6th. … If the exchanges allowed this argument to enter the mainstream press, the US stock market would be closed within a week. They are that dependent upon ‘flow’ to survive.”
Some algorithms, for example, can detect the electronic signature of a big VWAP, a process called ‘algo-sniffing’. This can earn its owner substantial sums: if the VWAP is programmed to buy a particular corporation’s shares, the algo-sniffing program will buy those shares faster than the VWAP, then sell them to it at a profit. Algo-sniffing often makes users of VWAPs and other execution algorithms furious: they condemn it as unfair, and there is a growing business in adding ‘anti-gaming’ features to execution algorithms to make it harder to detect and exploit them …
Whatever view one takes on its ethics, algo-sniffing is indisputably legal. More dubious in that respect is a set of strategies that seek deliberately to fool other algorithms. An example is ‘layering’ or ‘spoofing’. A spoofer might, for instance, buy a block of shares and then issue a large number of buy orders for the same shares at prices just fractions below the current market price. Other algorithms and human traders would then see far more orders to buy the shares in question than orders to sell them, and be likely to conclude that their price was going to rise. They might then buy the shares themselves, causing the price to rise. When it did so, the spoofer would cancel its buy orders and sell the shares it held at a profit. It’s very hard to determine just how much of this kind of thing goes on, but it certainly happens. In October 2008, for example, the London Stock Exchange imposed a £35,000 penalty on a firm (its name has not been disclosed) for spoofing.
Still, it’s probably nothing.
Update: From the comments…
I’m in software.
Years ago, I worked for a company that provided control software to the US Air Force. There were lots of papers to sign acknowledging the importance of “secrets” and we all had to sign waivers saying that we understood the penalty for divulging any material infomormation could include imprisonment in any NATO country…etc.
About two years ago, I interviewed for a job at a company that does nothing but high-speed trading algorithms.
The trading company was far more strict (and menacing) when it came to secrecy. It actually felt to me like they were some sort of cult.
I went through two interviews and, even at that point, they wouldn’t discuss the type of work they did. Instead, they’d just hint that it had something to do with the stock market. I knew who they were because a friend of mine had been through their grinder. But it was surreal…they wouldn’t even acknowledge that certain people had previously worked there.
Heck – at the end of the second interview, they weren’t even willing to name the job positions for which they were hiring.
Even the US Air Force wasn’t that super-secret.
I understand that these companies typically pay tens of millions just to buy old, plain looking brick buildings at “strategic” locations in New York, New Jersey, and Chicago – just to be physically close to the backbone of the systems on which the trades are conducted … thereby trying to gain microseconds of transaction speed over the competition.
Whatever their real impact on the markets, I am quite sure that these companies certainly see themselves as some sort of secret society.
I have no trouble believing that they have the ability to cause a flash crash. Honestly, I’m surprised we haven’t seen worse – and more often.
