"We risk becoming the best informed society that has ever died of ignorance"
- Rubén Blades

"You can't make up anything anymore. The world itself is a satire. All you're doing is recording it"
- Art Buchwald

"It's getting exciting now, two and one-half. Think of everything we've accomplished, man. Out these windows, we will view the collapse of financial history. One step closer to economic equilibrium"
- Tyler Durden

"It is your corrupt we claim. It is your evil that will be sought by us. With every breath, we shall hunt them down."
- Boondock Saints

Saturday, August 13, 2011

High Frequency Fraud

The world of High Frequency Trading is continuing its expansion into Main Street.  Slowly the population is learning of this manipulative and divisive trading behavior.  CNN Money decided to opine on the subject (for some real depth on the topic, go here).  I found instances, thanks to the statistical wizards at NANEX, since July 21st, 2011 (4 to be exact) where the computers stuffed the exchanges and delayed quotes.  How does it feel to know that while you worked hard or sweated about money that the computers managed to buy shares of Enstar Group for $0.0001 at 9:30:04 and sold it for $102.00 @ 9:30:05?  And as we like to see, Sal Arnuk of Themis Trading shares some reality with the slowly awakening crowd.  Something to note: "SEC doesn't entirely blame HFT on the Flash Crash".

Oh really, see here.  Notice what started the down fall, the CDS Quote Stuffing did, and of course, CNN didn't talk to the NANEX experts.  Don't be fooled by TheAtlantic article either, we all know that the algo's cause the dry up in liquidity when its needed and cause the flooding of money when it isn't needed.  Consider the NANEX article (here) where they chart the drop off in orders on all the exchanges since May.  In this picture, each line represents the total orders for all exchanges at the given time period, on the given date (which color coded)  The most recent line, for August 5th is, you guessed it, on the bottom.

From CNN Money:
NEW YORK (CNNMoney) -- The computers have taken over Wall Street, and they're taking investors on a wild ride.  This week, the Dow swung back and forth more than 400 points on four straight days. Trading volume is at or near record levels.  It's not fast-talking traders on the New York Stock Exchange behind the action. The majority of trading is done on large server farms based in New Jersey and elsewhere.

"These types of moves are certainly greater than anything we've seen in the last 10 years, and it's absolutely because now the majority of the orders are being done by these high-frequency trading robots," said Sal Arnuk, co-founder of Themis Trading, an independent brokerage firm.

High-frequency trading, also known as algorithmic or programmed trading, relies on software to determine when to buy and sell shares, usually based on a particular pattern or technical level in the market. These trades can happen several times a minute.

High-frequency trading makes up 53% of all trading in U.S. stock markets, up from 21% in 2005, said Larry Tabb, president and CEO of market research firm Tabb Group. Other estimates put it even higher, at around 65%.

Gary Wedbush, executive vice president and head of capital markets at Wedbush Securities, told Bloomberg News on Friday that more than 80% of the firm's orders since Aug. 1 have come from high-frequency trading clients, at five times the typical volume.

Nearly everyone on Wall Street is involved in algorithmic trading in some form, Tabb said, including large banks, hedge funds and mutual funds.

"These firms often piggyback on large orders, so it can amplify a stock's movement," Arnuk said.

Experts don't blame high-frequency trading entirely for the market's nauseating moves, but they say it certainly exacerbates them.  The Securities and Exchange Commission in a report blamed high-frequency trading in part for the May 6, 2010 "flash crash," when the Dow fell nearly 1,000 points in minutes.
 From TheAtlantic:

As the Dow has yo-yo'd through the past week, a familiar criticism has risen from the crowd. It's the computers fault!
Take this article from ABC, "High-Frequency Trading May Magnify Market Woes," in which the author leads with the idea that "experts believe that computer-driven high frequency trading is partially responsible for accelerating stock gyrations."
It's not that algorithmic trading couldn't have negative repercussions like last year's flash crash, but we know that there are so many human factors driving the markets crazy that we need real evidence for algorithmic hijinks before we should blame the bots. People like to scapegoat computers when the market starts doing things that are beyond any human's ability to tell a plausible story about. Dow down! Dow up! Dow down! Dow up! It must be the computers' fault!
Blaming computer-assisted trading has been a go-to strategy to explain market dips since the October 1987 market crash. "This computer-assisted trading trading has been credited with helping feed the remarkable run-up in stock values that began in 1982," the AP wrote days after the crash. "But in the wake of Monday's historic 508-point plunge in the Dow Jones Industrial average, the technique was being viewed as a destructive force." The Miami Herald was less measured; its headline read, "Computers Bring Doomsday to Wall Street." Even technology evangelists like the ones featured in the video above take it for granted that computerized trading might one area where computers were dangerous.
A lively and still unsettled academic debate ensued about the role of algorithmic trading, or program trading*, as it was then known, during the crash. Did it cause or exacerbate or have no effect on the market collapse? Various investigators told different stories with different data, as summarized nicely in a 1989 paper by Dean Furbush. "There is still no consensus as to the role of program trading in the crash."
In the popular imagination, though, computers certainly played a role in the crash. In 1988, the New York Times wrote, "The story of last October's stock market crash featured one notorious villain: program trading." The Times also noted that the practice hadn't gone away. In fact, computerized trading strategies have only become more prevalent over the 24 years since that crash.
Now, computers execute something like 75 percent of the trades on the major exchange, and when the markets are running smoothly, they seem to have a salubrious effect. But as a generally positive academic paper on the computerized practices concludes, "it remains an open question whether algorithmic trading and algorithmic liquidity supply are equally beneficial in more turbulent or declining markets."
Whatever the reality of the situation, when all hell breaks loose, we don't really trust the machines. We want some wet, sentient mammal eyes staring back at us when the bad times come. We want traders who feel pain. Like these guys, courtesy of The Atlantic business team: