Michael Lewis is wrong, says Knightmare on Wall Street’s Edgar Perez: Markets are not any more ‘RIGGED’ than before

Edgar Perez, Knightmare on Wall Street, The Speed Traders, US Securities and Exchange Commission

Edgar Perez, Knightmare on Wall Street, at US Securities and Exchange Commission (SEC)

According to Edgar Perez, author of Knightmare on Wall Street, The Rise and Fall of Knight Capital and the Biggest Risk for Financial Markets, stock markets are not any more ‘rigged’ than at the beginning of financial trading. He sustains that in free markets, participants are capable of making their own decisions. Different participants have always sought out an “edge” in different ways. Some do deep dives on the fundamentals, others look at related markets and others optimize for speed, therefore, arriving at different prices for the same instruments.

He further claims that all traders agreed on price, there would be no need for financial markets. Efficient markets need a mix a participants trading for different reasons and from different perspectives. Efficient markets are based on trust that the trading infrastructure will be up 100% of the time and that trading participants have systems 100% tested. That’s where regulators play a role by enforcing the rules that can strengthen trust in the market and stopping the “sad new market reality”.

Knightmare on Wall Street, The Rise and Fall of Knight Capital and the Biggest Risk for Financial Markets, was recently reviewed by The Huffington Post which praised its “great historical analysis and insights into what exactly went wrong” with Knight Capital. “Edgar Perez’s book takes the reader on a wild ride. A forensic analysis showed how an old forgotten line of code, like an ex-girlfriend, showed up and turned itself on, which began instantly trading a cascade of orders. By 10:00 am that morning, the Knight Capital IT team was able to stop the program, but it continued finishing trades for the next fifteen minutes. Then they began to assess the damage.

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High Frequency Trading: Clear and Present Danger?

According to huffingtonpost:

As we look back on 2013, it has certainly been a year of increasing scrutiny and criticism of capital markets trading participants. One particular area of focus is so-called “High Frequency Trading” (HFT), the practice of automated trading algorithms rapidly taking market positions. HFT is seen by many as a major cause of market crashes and volatility. Most notably, many believe the automated withdrawal of liquidity by HFT algorithms accelerated the 2010 flash crash, where the Dow-Jones Industrial Average dropped nearly 1000 points and then recovered most of the losses in only 30 minutes.

As Reuters recently reported, in Europe there is a lot of pressure from the European parliament to put measures in place to curb HFT. A proposed package of measures, including common tick sizes, synchronized exchange clocks to more easily spot abuse and more rigorous algorithm testing, are planned as part of the second Markets in Financial Instruments Directive (MiFID II). Crucially omitted was a much-debated point about minimum holding time for instruments, proposed at 500 milliseconds. Many high frequency algorithms might hold positions for a shorter time! However, this compromise might get the legislation through more easily. In addition, MiFID II will also limit the amount of liquidity traded on dark pools — off-market venues, where transactions are not transparent.

Great Gatsby

Earlier this year, Edward J Markey, Member of Congress in the U.S. declared that High Frequency Trading (HFT) “represents a clear and present danger to stability and safety of [US] capital markets and that it should be curtailed immediately.”

Congressman Markey backs his assertion with evidence drawn from market events, such as the Flash Crash and Knight Capital, as well as academic studies on the impact of HFT on markets and therefore main street. To summarize his points:
1.  The speed of HFT disadvantages other styles of trading 2.  HFT exacerbates volatility in the market 3.  ‘Other’ investors are scared away 4.  Volume traded by HFT is therefore a dangerously high proportion of overall traded volume

Not everyone shares Congressman Markey’s view. I was involved with a UK government-sponsored expert group called Foresight, which released its findings on “The Future of Computer Trading in Financial Markets” in November 2012. And Foresight’s findings were quite different! Foresight does not feel that HFT increases market volatility and raised some practical approaches to making markets safer for everyone, including circuit breakers and a consolidated tape. Foresight favored working with HFT to address perceived dangers is the committee’s preferred approach over banning HFT outright.
So where does the truth lie? Is HFT bad? Before we can answer that, we need to define what exactly is meant by HFT. A huge proportion of the market is certainly electronic trading and gone are the days of open outcry trading. However, much of that is more traditional large orders, for example on behalf of a pension fund, which may use algorithms to break them down into more manageable chunks and sequence these chunks in the market. Then there may be other totally automated algorithms trading for a proprietary trading firms that might hold their positions for hours or days. The Chairman of the CFTC technology advisory committee (on which I serve) Commissioner Scott O’Malia has been trying to get a good definition of HFT. He’s now got one, which is essentially “fully automated super speedy, short holding time”.

Within the ranks of HFT there are almost certainly bad apples. Several incidents of alleged market manipulation have led to fines, for example, the practice of quote stuffing in which a smoke screen of orders is used to mislead other market participants. Another big concern on market stability is trading algorithms going out of control — as we have seen many times, including at Knight Capital. This suggests a market not under our control. We must have better monitoring and control systems to prevent this from happening – or one can become sympathetic with the “speed limits” that U.S. and EU legislators might propose

However, there are many benefits to automated trading and arguably HFT is normal trading but quicker. If any market participant, high frequency or otherwise, attempts to move the price of an instrument (a.k.a. price ramping) by dominating the market (a.k.a. abusive squeeze), it is market manipulation. If said participant takes the position with the sole intention of immediately reversing it (flipping) for profit, or indeed to engineer volatility, it is market manipulation. These are well understood dangers of any style of trading and apply equally to HFT. To suggest banning HFT is to not understand that it’s the behavior that is wrong not the speed at which is takes place. The question is — do we have the ability to police trading at that speed?

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Brokerage offers platform for high frequency traders

Dubai: UAE’s fast diversifying financial services sector has led Abu Dhabi-based brokerage ADS Securities to invest in and develop a new trading platform that would allow it to tap into the high frequency traders segment.

With the HFT (high frequency trading) market growing in the region as more hedge funds and asset managers establish businesses and adopt sophisticated trading strategies, the brokerage saw an opportunity in supporting them by bringing trading business here and also, offering a local solution which supports them, said Philippe Ghnem, managing director and vice chairman of ADS Securities , in an interview with Gulf News.

Traditionally, investment in electronic trading was carried out by banks and large brokerages based in Europe and North America. But with this type of capital drying up during the global financial crisis, there appeared a potential for a Middle East brokerage to develop a trading platform that would offer a fast, efficient and competitive pricing option.

Though designed to manage all asset classes, currently, the proprietary platform called Orex Optim is available to trade foreign exchange and bullion and clients can pick from over 60 different currency pairs. Globally FX trading has now reached $5.3 trillion a day with a growing amount of this trade now being handled through the Middle East.

“Forex and bullion trading is increasing across the Middle East with many financial institutions recognising the benefits of investing in different asset classes which are liquid, making it very easy to enter and exit traders with buyers and sellers always available,” said Ghanem.

“Good pricing,” said Ganem, requires “having the right technology and being able to access market liquidity which is provided by banks and by other financial institutions. Again, the financial strength of companies in the Middle East means we can get good access to liquidity which can then be passed on to clients.”

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RBC: offers explanation for apparent decline in high-frequency trading

According to financialpost.com:

RBC Capital Markets is offering a simple explanation for why data released last week by the The Investment Industry Regulatory Organization of Canada appears to suggest high-frequency trading is in decline: Exchange Traded Funds (ETFs).

The Investment Industry Regulatory Organization of Canada noted in a report last week that the volume and value of high-frequency trading was down in 2012 and the first half of this year from when data collection began in the summer and fall of 2011.

The Investment Industry Regulatory Organization of Canada noted in a report last week that the volume and value of high-frequency trading was down in 2012 and the first half of this year from when data collection began in the summer and fall of 2011.

In a note sent to clients Monday by RBC’s global market structure team, analysts said IIROC did not appear to strip ETF market-making activity of Canadian broker-dealers from its data. This runs contrary to the decision of other regulatory agencies such as the U.S. Securities and Exchange Commission to make a distinction between ETFs and corporate securities in their data collection and analysis, the RBC analysts said.

“Beyond the implications that the inclusion of ETF flow might have had on the debate on the merits of HFT (high-frequency trading)… it even had an immediate impact on what the general public took away from the data,” the analysts wrote.

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High-frequency trading activity in Canada appears to have declined: IIROC

According to theprovince.com,

High-frequency trading activity in Canada appears to have declined since regulators began studying the lightning-fast trading strategies a couple of years ago.

The Investment Industry Regulatory Organization of Canada released interim results Thursday of a large-scale study being conducted on the electronic or algorithmic traders that profit in milliseconds from tiny price discrepancies between markets.

IIROC found that volume, value and trades attributed the traders within its definition fell to 16%, 24% and 34% of market activity in the 18-month period that ended in June. The comparable figures for the summer and fall of 2011 were 22% of volume, 32% of value, and 42% of trades.

Victoria Pinnington, vice-president of trading review and analysis at IIROC, did not offer an explanation for the decline, but noted that volume for TSX-listed companies remained at 21% in the most recent period.

Related

There is still much debate in the industry and among regulators about what constitutes a high-frequency trader or an HFT strategy.

There is still much debate in the industry and among regulators about what constitutes a high-frequency trader or an HFT strategy.

IIROC initially tracked traders identified by a high number of orders to trades, or a HOT factor. The self-regulatory agency of the investment industry has since fine-tuned the definition by adding other factors to help separate high-frequency traders from others in the marketplace.

Under the new definition, there are about 60 active high-fequency traders operating in Canada.

There is still much debate in the industry and among regulators about what constitutes a high-frequency trader or an HFT strategy.

IIROC’s full study on the subject, which is expected to analyze the impact of high-frequency trading on Canadian markets and other participants, is to be completed next year.

Computer-driven high-frequency trading emerged in the past decade when alternative trading systems sprung up to compete with traditional securities exchanges. It was lauded for bringing fresh liquidity to markets, but critics say it puts other traders at a disadvantage and drives up the costs of trading.

The “flash crash” in May 2010, which was not caused by high-frequency traders but was perceived to have been exacerbated by them, prompted regulators in the United States, Europe and Canada to take a hard look at the trading strategies.

In February, IIROC spelled out five trading strategies associated with high-frequency trading that it views as “manipulative and deceptive.” These include baiting bids by entering orders at a certain price when the trader has no intention of completing a transaction at that price.

IIROC has also implemented a fee model that penalizes traders whose messages to the marketplace outstrip trades. This creates a disincentive for some high-frequency trading strategies.

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Supercomputers VS High-Frequency Trading: Analysis Leads to New Regulatory Law

According to ScienceWorldReport,

When there’s money to be made, most loopholes have already been  explored and exploited – but emerging technologies are changing the  game, creating new opportunities for moneymakers and headaches for  regulators. To counter this, researchers are now using supercomputers to help regulators  determine which policy changes will ensure a fairer, more stable market.

New York City

New York City

With the advent of high-frequency trading, traders can use superfast  computers – essentially supercomputers of their own – to compete in the  market, taking advantage of brief price differences to clean up on  profit. For example, if a stock is momentarily priced slightly lower in  New York than in London, high-frequency traders can almost  instantaneously buy and sell for risk-free returns.

Such rapid-fire trading – trading often completed in microseconds, or  even nanoseconds – can lead to market instability, and regulators  haven’t been able to keep up with these shenanigans of high-frequency  traders. This volume makes it significantly harder to identify the root  cause of a problem. For example, when the Dow Jones fell nearly 1,000  points in 20 minutes in the ‘Flash Crash’ of May 2010, it took US Securities and Exchange Commission regulators five months to analyze the data and figure out what  happened. As it turns out, the culprit was flawed automated trading  software.

However, sometimes it’s not a software glitch that’s causing  the problem. Sometimes high-frequency traders are causing market  instability on purpose with a practice called ‘quote stuffing.’  Essentially, a high-frequency trader places an order only to cancel it  in .001 seconds or less, solely to cause congestion. The trouble: It all  happens so quickly that it’s hard to prove. That’s where supercomputers  can help.

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Markets Evolve, as Does Financial Fraud

According to Dealbook,

It is usually the case that there are not new frauds, just new avenues for deception. As the financial world has evolved into a high-speed race to trade assets while investment strategies are kept secret, both regulators and investors face the challenge of finding the fine line between permissible trading and manipulation aimed at generating unfair profits.

As the markets have changed, with high-frequency trading firms buying and selling financial instruments in the blink of an eye, so have the monikers used to describe misconduct. Yet the underlying goal of manipulating prices remains the same. Long ago, stock trades were reported over ticker tape, and one type of manipulation was called “painting the tape.” Traders would enter orders to give the appearance of activity in a stock to entice others to buy shares, thus pushing the price higher.

Today, a slightly more sophisticated scheme is called “banging the close,” in which transactions are made in one market at the end of the day to benefit a trader’s positions in another market, say derivatives. Same scheme, different means.

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BIOS IT launches ultra-fast server solution for high frequency trading at Low Latency Summit New York

According to SourceWire,

Traders work on the floor of the New York Stock Exchange, November 14, 2013. REUTERS/Brendan McDermid

Traders work on the floor of the New York Stock Exchange, November 14, 2013. REUTERS/Brendan McDermid

BIOS IT, a partner of Super Micro Computer, Inc. (NASDAQ: SMCI), is proud to announce the availability of the next generation of Hyper-Speed Solutions, designed to deliver ultra-fast high performance for high frequency trading and other mission critical environments. Now in its third generation, the Hyper-Speed range has been upgraded and accelerated by using ‘Ivy Bridge’ processors and system firmware optimisations that lower median latency by 15% and reduce jitter by 94%.

Based on Hyper-Speed technology, BIOS IT and Supermicro are able to enhance the highest performance Intel® Xeon® E5-2600 V2 series processors (up to 150W TDP) in order to achieve application performance improvements of up to 30%. Hyper-Speed solutions are available in Tower, 4U and 2U rack-mount configurations to benefit and assist a variety of different workloads, tasks and applications. The Hyper-Speed 6027AX-72RF workstation and TRF-HFT3 servers speed up trading by 15% and lower jitter – a jumpy movement or instability in computer systems – by 94%.

The launch of the new Hyper-Speed range comes at a time when High Frequency Trading is set to increase by over 20% by the end of 2013. According to TAAB, HFT now accounts for over 40% of the global currency trading.

Ian Mellett, General Manager of BIOS IT, says, “Once again we are pleased to be working closely with Supermicro, demonstrating new technologies at the Low Latency Summit in London last month and New York this month. We are excited about delivering accelerated computing, networking and I/O to the city.”

“As firms continue to process increasingly large volumes of trades in smaller, critical timeframes, the consistency and efficiency of Supermicro’s Hyper-Speed solution range ensures the fastest overall performance with maximum reliability for even the most demanding trading environments.”

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How high-frequency trading took the soul out of my career

Neil J. Solanki, Copyright © 2013 Chicago Tribune Company, LLC

Neil J. Solanki, Copyright © 2013 Chicago Tribune Company, LLC

In the view of Chicago Tribune Company: It was not subtle. It was not pretty. And yes, it felt mechanical. When the robots came a callin’, it felt like mathematics came and stomped the very soul out of the market.

The robots were computers that enabled high-frequency trading, the rapid buying and selling of stocks and other financial products using automated algorithms. The practice now dominates the financial markets, including the Chicago Board of Trade and Chicago Mercantile Exchange. That’s where I traded futures while I worked for Chicago firms like Gambit Trading.

High-frequency trading has been blamed for “flash crashes” and for August’s three-hour screeching halt at the Nasdaq. In September, regulators convened to outline proposals aimed at reining in automated trading. I’m not making any claims about whether this trading is of benefit to society or improves market functioning. I simply aim to give an anecdotal and experiential account of what I saw in my 10-year career.

When I started in 2004, Chicago was like a Wild West town. There were the old cowboys who had been bootstrapping it from the beginning (local small traders). There was a town barber and haberdashery (assistants and others necessary to grease the wheels of general operations). There was a town bank (the stock and bond exchanges and clearing firms). There was the railroad (the biggest banks and trading firms controlling the major market flows, i.e. the Goldman Sachs types). Then there were the young guns looking to take a piece of the pie.

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Are High Frequency Traders Too Slow?

Knight Capital booth at NYSE (Bloomberg)

Knight Capital booth at NYSE (Bloomberg)

According to Bloomberg, high frequency trading is a wonderful subject for study because nobody agrees on what would make it Good or Bad. So academics and practitioners can write papers about how it is Good, or how it is Bad, and they don’t particularly contradict each other because they measure different things and the actual thing that one wants to measure is hard to nail down and would probably be hard to measure even if you knew what it was.

So here we are with an interesting European Central Bank working paper from Jonathan Brogaard, Terrence Hendershott and Ryan Riordan about high frequency trading.* They’re mostly for it, which has naturally gotten them some attention. They think that the things you should measure are along the lines of “does high frequency trading improve market price discovery?” and “does it provide liquidity?” and I guess if they thought it was Bad, they’d be asking different questions. But they answer yes to their questions: They find that high frequency trading improves price discovery, and that it does not cause instability by withdrawing liquidity during volatile periods.

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