Flash Crash Analysis of May 6 Stock Market Plunge 411
Jamie found an interesting site that has many charts and graphs about the strange May 6 stock market plunge and rebound. There's a lot of information to consume over there, but it does a pretty good job of showing high-frequency trading is getting to be a real problem.
It should Flash Crash to about 5000 (Score:5, Insightful)
HF Trading reduces spread, increases liquidity (Score:5, Insightful)
High Frequency Trading is _beneficial_ to the public markets at large, and why powerful interests keep blaming and attacking electronic trading as the root of all financial evils that befall us: http://www.tradersmagazine.com/news/high-frequency-trading-benefits-105365-1.html?zkPrintable=true [tradersmagazine.com]
Unfortunately, the majority seem to be believing Rupert Murdock's Wall Street Journal and similar mouthpieces spouting all the "Electronic Trading must be taxed/stopped/restricted, it is destabilizing markets" rhetoric.
As mentioned in above link and In case you did not hear about the New York Stock Exchange specialists charged with fraud, an event referenced in the above link - it's pretty amazing: Richard Ney wrote a best selling book in 1970 ("The Wall St Jungle", interview NY Magazine 1970) with a few follow up books that all called out the NYSE Specialist families for fraud, explaining exactly how they defraud the public. At the time The Wall Street Journal boycotted anyone selling the best seller and Ney was not permitted as a guest on The Tonight Show - very unusual at the time for someone with such a long run best seller/controversial book - his message had touched a raw nerve. In response, the establishment had Ney widely counter-attacked, labeled a conspiracy theorist nut at every opportunity - comments like "what would an actor know of the stock market" were common and can be heard even today.
To prove Ney's wild eyed grand conspiracy theory right - The Department of Justice finally got around to charging the NYSE specialists for the exact fraud that Ney described - 33 year's after he wrote about the crime! In 2003 the Specialist firms quickly got their get out of jail free cards for a tiny fraction of what they had actually defrauded over the years. The story does not end there however... news came out shortly after that the NYSE was at long last going to move to an all-electronic exchange - and that the Specialists firms charged with defrauding the public were the very same that had been blocking the move due to their 30% NYSE stake. Everyone in the know + those that read Ney's book knew all too well of the massive fraud going on in full public view for at least 33 years (more like 212+ years), but it was not until these Specialist criminals blocked other powerful interests that the illegal behavior was actually pursued by the DOJ.
If ever there was an example of the lack of credibility for the DOJ, this is it. 33+ years of massive fraud in full public view, but the DOJ did not get around to prosecuting until it was ordered to - until it was necessary to coerce the Specialist family firms into letting the NYSE go electronic. Nothing to do with justice, or protecting the innocent being defrauded to the tune of billions of dollars over the decades. As an added insult, the DOJ let the criminals off the hook with a paltry fine. But then there is no surprise there, as Richard Ney said it best: "Regrettably, the arrangements that exist to preserve the traditions and legalize the frauds of the security industry are inseparable from the general organization of a society controlled by the financial establishment, a society whose laws and principal customs have been contrived to serve the special interests of the financial community,"
Voting Red or Blue will not change this arrangement of US society and it's laws - merely reinforce it.
Re:How is this a problem? (Score:5, Insightful)
Old way: 10,000 trades a day, every few months or years the market dips for a few months and rebounds, every several years the market enters a deep recession for years.
Yet it doesn't have to be that way. the problem is people put money in the stock market because they want to make money, not because they give a sh*t about the companies they're investing in or their products/services. the result is everything becomes about making profit now instead of building long-term stability.
Fluctuations are one thing, but those "deep recessions" are all the result of a small group of people doing incredibly stupid things in the name of short-term profitability.
These high frequency tradings should be banned. They contribute absolutely nothing to the market, the companies or the shareholders at large. All they do is extract money at the expense of the market's overall health.
=Smidge=
Re:How is this a problem? (Score:5, Insightful)
The real problem is the reliance on the stock market as a measure of the economy in the first place. The stock market is a completely artificial construct that has nothing to do with anything. It would be best if people just ignored it.
Look at this recession for instance. If you look at the stock market you'd think that the recession is over. Fat lot of good that does for all the people who are still out of work. And no, unemployment is not a "lagging indicator", it's the only thing that matters.
barrier of entry is a problem (Score:5, Insightful)
those with the screamiest servers the shortest fibre optic hop away from wall street get to play this game, no one else. it dedemocratizes the market. the ideal of a marketplace is that it is a meeting place of equals. if the guy with the most expensive servers and programmers money can buy is the only one who can profit though, the marketplace is now simply an oligopoly of the rich, not a place where the common investor can make his or her mark
of course, the market has never been a meeting place of equals, it has always been abused by the largest players in the marketplace. however the idea is to minimize this abuse, not excuse or accept it
what the market needs is a "tick", a "heartbeat": all trades, no matter from whom, must be made in the same 1 second or three second batch cycle. no one should be allowed to exceed this frequency. problem solved
Re:How is this a problem? (Score:5, Insightful)
Because it's no longer investing.
It's gambling.
In gambling, the only winner is the house. In this case it's the brokerages.
I hope this helps.
--
BMO
Re:It should Flash Crash to about 5000 (Score:3, Insightful)
June 2009, the dollar was .71 against the Euro. Lately its been floating around .85. So, the dollar is worth a little more. On top of it, stock values fell due to the recession.
As far as some kind of Joe Sixpack "that company aint worth that much" sentiment, well, the stock market has never been a rational system. It trading system. The mob mentality defines the prices. If the mob thinks Pokemon is worth a bazillion dollars and people are willing to spend all this money on Pokemon, the guess what, they are right! Nothing is worth anything, in a real sense. Gold is just some random metal. Currency is just some paper. Worth is a fiction dictated by markets.
Re:It should Flash Crash to about 5000 (Score:5, Insightful)
Like the man said (thousands of years ago): "Everything is worth what its purchaser will pay for it.".
Re:How is this a problem? (Score:5, Insightful)
Old way: You give your cow to a servant to take it down to the market to sell it, and there's a bunch of people there who are willing to give him a fair price. Flash crash way: You tell the servant to take your cow down to to the market and sell it, but everyone's really busy and a little skittish, and since you told him to sell it now he sells it to a bum on the street corner for a nickel, then everyone panics: "the price of cows has fallen to a nickel! woe and ruin!" until some people wise up and realize they can buy cows on the cheap, and do so.
Market orders. Go figure.
Re:How is this a problem? (Score:2, Insightful)
Re:It should Flash Crash to about 5000 (Score:5, Insightful)
Something is worth what you can convince the dumbest person you can find to pay for it.
The stock market makes it easier to find dumb people.
Re:It should Flash Crash to about 5000 (Score:3, Insightful)
If you know what companies are 'worth' why aren't you out making a pile of money either shorting them if they're too high or buying if they're too low? What exactly justifies your price of 5000? Really, what defines the worth of a company? A company's worth isn't some discretely tangible thing, as much as we'd all like that. You buy or sell stocks based on what you think the price and dividends are going to be at some point in the future. Which can suddenly change if you know... there's a major oil spill in the gulf of mexico. The DOW average is just a collection of some companies, which can then wildly distort the picture. Last year (roughly) GM was on the DOW but they went bankrupt, so just a guess, but that might have dragged the market down a bit. On June 8th of 2009, so my 'roughly' one year ago, citi and GM got tossed off the DOW. So maybe the new DOW really is worth a lot more, or at least is projected to be worth a lot more.
As to your assertion that it's being propped up by funny money. Well not exactly. I'll grant that the US dollar is a bit screwy, but since the DOW is in US dollars the the dollar could change down -50%, DOW could change +100%, and the total value if you were to consider it in Euro's would be unchanged. Of course the US dollar factors into things because people are more confident in the US managing its debts than say, botswana or nigeria, or the PIIGS. Of course in that situation, in the the last year, money will have been taken out of those foreign accounts and dumped into US dollar businesses, which in turn inflated both the dollar and the DOW, and reflects a real shift in money from one region to another.
Re:more sensible trading (Score:3, Insightful)
I mean really, what could happen in 24 hours that would honestly affect the value of a publicly traded company?
Exploding factories. 9/11. FDA investigations. FBI raids on corporate HQ. CEO arrested for fraud. CIO arrested for selling customer CC info to Russian hackers. CFO arrested for securities fraud. Announcing a new product. Announcement of a massive merger.
Lots of things can affect the value of a company over a short period of time.
If you want to change the system I am cool with that. I do not though think there is any need to outright deceive people with a stupid question like that to "prove" your point. All you do is prove that you need to not be trusted.
Re:HF Trading reduces spread, increases liquidity (Score:5, Insightful)
Re:It should Flash Crash to about 5000 (Score:2, Insightful)
Yeah but doesn't that mean the companies are worth 1.5 times what they were last year? That's only 50% more.
Quote Stuffing = DDOS Attack (Score:4, Insightful)
From a few pages into the write-up (http://www.nanex.net/20100506/FlashCrashAnalysis_Part4-1.html):
Definition of a DDOS (from http://searchsecurity.techtarget.com/sDefinition/0,,sid14_gci557336,00.html [techtarget.com]):
Quote stuffing looks like a DDOS to me, and should automatically be illegal. Of course, there are several technical differences that any lawyer could point out,thus making quote stuffing legal, so I'd recommend outlawing it just to be sure. Not often I get to say, in all seriousness, "There ought to be a law." {Most situations do not require new laws, only the proper application of existing laws.}
Re:How is this a problem? (Score:4, Insightful)
Put the brakes on a level up (Score:5, Insightful)
Instead of putting in fixes at the exchange level, put something in at the SEC regulation level so it applies to all US exchanges. And yes that'll stabilize foreign exchanges too. Think about supply and demand and what sellers do when prices drop in market A and don't drop (or don't drop as far) in market B.
First option: bunch trades by time. Define a market tick, say 2 seconds. All trades that come in in a given tick get bundled together and executed as if they'd arrived in a random order at the end of the tick. The exchange is allowed to use any method to randomize and order the trades, the only rules are that the method can't be based directly or indirectly on the original arrival sequence or the original arrival time and the method can't give preference to any particular trader or type of trader. The bunching should have no effect on people who trade on timescales more than about 2x the tick, but makes trading on timescales less than the tick infeasible because the market simply won't execute your trade any faster than the tick.
Second option: random delays. Define a market tick, say 2 seconds. All trades, as they arrive, have a random delay between 0 and the tick length calculated (same rules as option 1) and have their execution delayed by that much. You're guaranteed to have your trade executed within 1 tick of it's arrival, but you can't know when within that 1 tick it'll actually be executed. Again the delay should have no effect on people trading on timescales larger than about 2x the tick, but trading on timescales less than the tick becomes infeasible.
That should smooth out the noise caused by high-frequency trading without seriously impacting things for anybody who's not trading on sub-second intervals. And it avoids the whole quagmire of trying to ban every different way of doing high-frequency trading and seeing the HFTs try to find loopholes and methods you haven't banned yet by simply setting a time resolution for the exchanges below which everything's just random noise.
Re:ZeroHedge had a discussion on the Nanex report. (Score:1, Insightful)
The single port theory from zerohedge assumes a firm uses only one port; they can have more than one. If one provider fails, they have an alternate venue for trades. Quote stuffing could happen through one venue while major plays happen on another. It *could* happen that way.
Re:Summary... (Score:3, Insightful)
Even professional math/finance PhD folks can make disastrous mistakes. Long Term Capital Management was founded with two Nobel Prize winners in Finance... didn't stop them from blowing up and needing a bailout.
Re:It should Flash Crash to about 5000 (Score:5, Insightful)
So yes, the 1.5x valuation is fully warranted today. Whether that will still be true tomorrow is debatable.
Re:HF Trading reduces spread, increases liquidity (Score:2, Insightful)
you are arguing in favor of inefficient markets
More specifically, he's arguing against arbitrage, which is what HFT is. A is selling stock for X, B is buying stock for Y, X is less than Y so the HFTer gets their buy order in before X or Y realize their mistake, making Y-X from each share. They don't "create volatility," buyers and sellers were already there, they just take advantage of the fact that some people have better pricing information than others.
Re:How is this a problem? (Score:1, Insightful)
What makes you think HFT are buying everything and selling everything. They get in only when they notice a large enough gap between buyers and sellers. Then they jump in and take advantage of that gap to make a profit. That is plain government sanctioned stealing. In fact, because the take out profits from the deal, they are actually reducing liquidity.
Re:HF Trading reduces spread, increases liquidity (Score:5, Insightful)
A high speed trader does not increase liquidity, because for a high speed trader to work it has to know that It can buy something now and sell it moments later. This means the initial seller and the final buyer already existed before the high speed trader got involved, they just hadn't found each other yet. The item being sold was already as liquid as it was going to get.
Re:HF Trading reduces spread, increases liquidity (Score:4, Insightful)
I find this defense of high speed trading odd -- it puts the cart before the horse. Liquidity is not a good in itself which should be promoted above all else. Liquidity in a market is important so that the price can correctly reflect the value of the thing being traded -- without liquidity a person may want to buy or sell without someone on the other end and thus the price may not reflect the actual value.
But, if high frequency trading creates liquidity but does so by also introducing price distortions (like a sudden crash), then we *should* get rid of high frequency trading so that we can maintain correct (and mostly stable) prices.
Re:If you think the game is rigged, why play? (Score:5, Insightful)
Either you trust them and you play their game, or you don't and you find some other way to invest your money. It would seem that generally the clientele are pretty pleased with their results.
The reason the stock market goes up is because more and more money goes into it. The reason more and more money goes into it is because governments around the world give preferential tax treatment to 'investments' in pension plans and the like, so people keep putting money in there in the hope that they'll get more back that way.
So, as usual, the root cause of the problem is the government funneling money into the markets through artificial incentives. Eventually people will start to realise it's a scam and stop throwing money away so that bankers can buy their third Porsche.
Re:Summary... (Score:4, Insightful)
It's a bit unnerving that no one caught the potential for this considering what's at stake (and at the same time you have people overly concerned with things as comparatively mundane as the security of operating systems). Well, someone did find the exploit, but it was found by the wrong party.
Re:barrier of entry is a problem (Score:5, Insightful)
if the guy with the most expensive servers and programmers money can buy is the only one who can profit though, the marketplace is now simply an oligopoly of the rich, not a place where the common investor can make his or her mark
I think this is a great explanation of why high frequency trading bothers people. It amounts to, If you have the connections and resources to create this super-fast setup, you can get a piece of everything without actually doing anything. You don't produce anything or provide any service. You just force yourself into the position of taking a cut of other people's business deals.
HFT *DOES* need to be regulated differently (Score:3, Insightful)
FTFA:
"Add a simple 50 millisecond quote expiration rule: a quote must remain active until it is executed or 50ms elapses. If the quote is part of the NBBO, it may be improved (higher bid or lower offer price) at any time without waiting for the expiration period. "
Um, 50ms is not a humanly realistic decision span. It takes longer than that to recognize the color of the arrow pointing in the direction your stock price is going.
HFT is the epitome of arbitrage, and competed directly with human (or flesh-and-bones) trading. They should play by common rules that are at least realistic for both. This means that quote expirations should be measured in full SECONDS, not milliseconds.
This will, of course, destroy the obvious and worst advantage HFT has, that is the millisecond response to arbitrage opportunities. But it will allow at least the dedicated human trader an opportunity to participate in a market they are now just being beaten to by a machine.
We wouldn't allow a professional baseball team to use a mechanical pitching machine instead of a real-life pitcher. Dialing the speed up to 150MPH wouldn't enhance the game, and would instead overwhelm human batters with little hope of success no matter their skills. the game is INTENDED to be played between humans, as a test of skill and determination.
Stock trading should, in my humble and entirely uneducated opinion, be a game played among relative equals. HFT is breaking this in a way that is not useful to the market, does not add value to the capital stocks being traded nor the companies and shareholders represented, and defeats even the most concerted efforts by human traders to participate on even a marginally equal footing. No amount of analysis or even reaction by a real life trader can survive head-to-head with an HFT system.
If the purpose of the Stock Market is to offer opportunities to profit from purely technical conditions, even to allow profit from malfunctions, then HFT fits right in. But if the Stock Market is intended to provide opportunity to raise capital, develop value, and gain profit for those with good decision-making skills and insight, then HFT is an 'unfair' advantage to machines at the expense of all other players.
It is also, clearly, dangerous, and can cause significant disruption as well as loss to other players, in circumstances that are not related to actual market or economic conditions. A 'simple' delay of a few milliseconds in system response can result in the feedback loop observed in this case, and that is not useful to the markets. Quote stuffing is pure fraud. In fact, much HFT activity borders on fraud, as it is intended to deceive other players. Yes, it is. Looking for the arbitrage opportunity on a millisecond scale is nothing but machines battling machines. The only realist hope is to catch one in a moment (a definitely short moment) when something is not working right, and score.
Yes, HFT programs work to catch opportunities, and generally do with no great risk to the overall market. But in my naive opinion, this is not really useful to the market, nor the national economy as a whole.
Perhaps I should be asking the other question - does the Stock Market now serve the economy in a beneficial way, or is it now the province of software and arbitrage, primarily serving those who seek to take advantage of even momentary mismatches of pricing? And should it be permitted to continue down this road to the point where it is no longer feasible for a human trader to participate in short-term trading?
My investments are in mutual funds that exercise restraint and hold stocks for longer periods. If I were buying single issues, I would be planning on holding them for years in most cases. And I would feel genuinely cheated if I happened to choose to sell a stock at the same time as the market suffered a purely technological dip, and I was faced with a 30% drop in value for no reason other than the NYSE was queueing quotes for 20ms longer than normal.
Clearly, I have a naive view of the market. I think it should serve some purpose other than it seems to now. I know.
Re:How is this a problem? (Score:3, Insightful)
Since nothing is actually produced - the ground starts out flat and it ends up flat - there's no difference between that and simply giving them the money for sitting on their butts. And yet, I remind you, the claim was that employment per se was what mattered. Actually what matters is useful employment.
And the increased demand will drive up prices for them - and for everyone else. Might as well have told those who were already working to give away some of the bread they buy. Where some = the difference between what they could afford before and what they can afford now.
Nothing extra has been produced, it's just redistributed.
P.S. I'm no fan of the bankers, but that's completely irrelevant to the point at hand.
Re:HF Trading reduces spread, increases liquidity (Score:5, Insightful)
I guess that depends on your definition of "inefficient."
Lets say you're at the supermarket.
You reach out your hand to take [product] off the shelf,
by the time you reach out to take another [product], the shelf is empty!
The market is more "efficient" in the sense that the seller obtains the lowest price he is willing to accept and the buyer pays the highest price he is willing to give. "Efficient" in the sense that, as long as those two prices are different, there's room for another middleman. The arguments for HFT, taken to their conclusion, would claim that every purchase should pass through as many hands as possible, in order that the person who actually created the economic value in the first place makes no profit, the person who finally benefits from the widget has paid so much that he'd reverse the sale for a penny, and a whole chain of bankers and lawyers have divided the difference.
It's like a steam plant: there's a particular shape of turbine where the steam expands reversibly and you maximize the conversion of heat to work. The chamber has to expand infinitesimally, to balance the infinitesimal cooling and depressurization of the steam.
The economists are completely agnostic to who gets the money: they only care that it gets paid to someone. Economically, no purchase should ever make you happy or improve your condition. If you are better off after your purchase, then the seller should have charged more. Or someone should have added a middleman-markup.
Re:How is this a problem? (Score:3, Insightful)
Indeed, as the 1930s humorist Will Rogers said, "A recession is when your neighbor is out of work. A depression is when you're out of work!
"Jobless recovery" is an insult to every working person everywhere.
Re:Zero Sum is NOT productive... (Score:3, Insightful)
I'm not so sure they're actually taking any risk, to be honest with you. I think that's really at the heart of this all.
Let's say you stuck 2002's Michael Vick (you know, when he was an NFL cheat code) into a Midget league. Technically he'd be taking a risk every time he took a snap and ran with it, but realistically the outcome would be exactly what any and every reasonable, non-insane person would predict.
Or maybe you're playing poker and all your opponents have wire hats, and you're a computer. You can read the impulses coming through those wires and through that determine what they're about to do just after they decide that's what they're going to do but before they're actually able to do it. If you're fast enough, you can slide in between the decision being made and the action being done. That's not gambling, that's fucking CHEATING!
I don't care for or know much of economics and the stock market, but I do know about exploiting loopholes in games and HFT looks to be drool-worthy when it comes to gaming the system.
I'll stop short of calling it evil and saying it must stop, but at the very, very least it's something that ought to be very fucking closely looked into. Just because it's capable of making itself money doesn't mean it's good for the market, and not everything that's good for the market is good for us (and, of course, we're not REALLY talking about "the market" but rather "the stock exchange, which we say is representative of the market", which is a DIFFERENT beast).
Re:Zero Sum is NOT productive... (Score:3, Insightful)
The HFT guys build a position, thereby taking on risk.
Show me five HFT guys who have gone broke in the past year.
The operational meaning of "take on risk" is "sometimes goes broke." If you can't show me the bankruptcies, your claim of risk is just false.
Re:How is this a problem? (Score:3, Insightful)
"Investing is gambling."
Only if you have a broad enough definition as to make the word "investing" useless.
Buying a company because you've done research and think it makes a worthwhile product (widget, service, whatever) is far different than buying/selling on "spread" and wild, factless speculation that is little more than throwing darts at the financial page tacked to a wall.
Berkshire Hathaway isn't gambling. Spinning a roulette wheel is.
To insist that buying and selling stocks is (or should be) a game of chance is a dangerous mindset.
Indeed, it's beginning to become obvious that the "game" of this "gambling house" is rigged by the High Frequency Traders. Reputable casinos make sure that games are at least consistent and the rules understood because bettors would simply leave. What we have now is potentially worse. What happens when there are *no* reliable house rules at all, like we saw with this nearly instantaneous crash? You want to see a stock market crash that makes 1929 look like a dip in the road? Remove all faith in the system like this has the potential to do.
Writing this off as "just one of those things" is myopic and dangerous. Do you really want to see what happens when most people are at a disadvantage because they are not 10 or 5 milli-light-seconds away from the trading computers? Do you really want to give the advantage to those who are physically situated close enough or do you want a level playing field for everyone?
Because that's what's happening with HFT. It's all about a game about who can take advantage of the speed of light instead of investment.
--
BMO
Re:HF Trading reduces spread, increases liquidity (Score:1, Insightful)
Switching to a micro-auction market would kill this kind of trading. That is, the continuous, price-time priority match of all the current US markets would be changed to mini auction matches that would occur maybe twice a second. This would give plenty of time for all market participants to react to a change in market conditions and get their orders in. Being one microsecond faster than the next guy will no longer make a difference.
An added benefit would be that you could increase interval between auctions if the number of buyers or sellers rapidly decreases. In the case of the fast-crash on May 6th, when buyers disappeared, you could start doubling the time between these auctions to one second then two seconds, etc, until buyers started to appear. The price drops would have been far less scary and computer models would have had more time to figure out what was going on.
Re:It should Flash Crash to about 5000 (Score:3, Insightful)
So all buyers are dumb?
With the P/E values in todays stock markets there are only two categories of buyers. Idiots and Gamblers.
Re:HF Trading reduces spread, increases liquidity (Score:2, Insightful)
Economically, no purchase should ever make you happy or improve your condition. If you are better off after your purchase, then the seller should have charged more. Or someone should have added a middleman-markup.
Ugh. This isn't insightful; it's absurd. If we take your logic to its conclusion, there's no such thing as a middleman markup. Because then that middleman is the customer and yet another middleman should have already added the markup.
The truth is that economic value is subjective. Economically, *every* purchase should make you happy while simultaneously making the seller happy. Because you both value the thing differently. If this wasn't the case, neither of you would have any incentive to make the deal.
HFT changes none of this that I can see. There are more opportunities for middlemen, but as long as I get the price I wanted, I'm still happy (just maybe not as happy as I could have been had I been in the middleman's position). I don't see the great evil of being a middleman; life's unfair and some people are in positions to exploit price differences. As long as they don't commit fraud to do it, what's the big deal?
Re:HF Trading reduces spread, increases liquidity (Score:3, Insightful)
Flash trading is the main sub-form of high-frequency trading which is responsible for overwhelming majority of its profits. From macro-scale point of view, they are one and the same thing.
Re:Logically flawed (Score:1, Insightful)
The idea is that the shareholders of a growing company are better off if the profit is reinvested into the company, such that the company can grow and pay a much larger dividend in the future once it has become large. Moreover, if the profit is paid out as a dividend, the shareholder has to pay taxes over this income, whereas a growth in the value of the company is often tax free (depending on the local tax regulations).
Of course, this only works if the profit is reinvested in a meaningful way. During the internet bubble, companies were more or less burning cash as a substitute for solid investments.