Summary of Written Testimony for Computerized Trading

I wanted to collect my thoughts on the Senate Testimony today at 10AM. Apparently there will be a live webcast via this link: http://banking.senate.gov

As for my background, I have been an active trader since 1987, and manage over 5B in AUM. We are not market-makers and do not participate in high frequency trading of any type. However, we use computerized execution algorithms to adjust our portfolios each day in equities and futures markets around the world. Our average holding period is 7 days, and our minimum holding period is one day.

In order from most anti-HFT to most pro-HFT:

David Lauer

Mr. Lauer continues in the grand tradition begun by others that HFT constitutes a clear and present danger to our financial system. In my opinion he asserts inaccurate claims concerning the May 6, 2010 Flash Crash. Please see my blog post http://www.transparentsimplicity.com/2012/09/flash-crash-reactions-may-8-2010-so-i-dug-in-to-look-at-what-was-very-fast-action-in-a-classic-cascade-downward-across-a.html.

Interestingly, Larry Tabb (another Senate witness) addresses this type of hyperbole by listing 12 other non-HFT  factors that might be contributing to declining investor confidence in the markets.

On the positive side, Mr. Lauer’s written testimony offers poignant arguments against burgeoning message flow, exotic order types, dark pool opacity, and absurdly short order lifetimes. In addition, the points about complexity’s role in creating unfair opportunities ring true across a far wider stage than just market micro-structure. I especially appreciated Mr. Lauer’s quite novel idea of open-sourcing the data and setting up a contest-like environment to “…find innovative ways of designing surveillance systems and algorithms.”

 

Andrew M. Brooks

Mr. Brooks echoes much of Mr. Lauer’s testimony, although in far more succinct form, and without the sweeping conclusions about HFT’s negative impact on the financial world. He suggests that pilot programs be used to test out various solutions to the major HFT issues.

 

Larry Tabb

Mr. Tabb’s testimony is much more descriptive of market structure and definitely is the most detailed and specific about the issues. I believe that his testimony is fairly even-handed and sober. He does state that our markets are overly complex, and goes into some details as to why that is a major problem. He writes at length about the issue of less liquid stocks and how the current market structure is tilted towards trading optimality for the stocks of the largest companies.

Two very interesting assertions are that “The current market structure benefits small investors” and “Day traders are completely disadvantaged.” As mentioned above, he goes into many reasons for dropping investor confidence that fall outside the scope of market structure. Instead of recommending that complex order types be banned, he recommends more transparency in the exchanges’ order descriptions.  There are a lot more specific recommendations in his testimony.

Chris Concannon

Mr. Concannon works for Virtu, an electronic market maker. He cites complexity as an issue; so, unanimously, the witness panel agrees that our markets suffer from too much complexity. However, he blames what he calls “major regulatory reengineering events.” I am especially annoyed that he doesn’t mention the proliferation of order types that has played a huge part in un-leveling the playing field with unnecessary complexity. He calls for “… the need for additional obligated liquidity in our market.” Interestingly, most of the issues cited by the other panelists are not mentioned by Mr. Concannon.

Flash Crash Thoughts

Flash Crash reactions – email written May 8, 2010, 2 days after the Flash Crash
So I dug in to look at what was very fast action in a classic cascade downward across a bunch of correlated market sectors.

I dug a bit deeper into the actual trades that took place in the futures markets, as well as in cash foreign exchange to understand the timeline better.

The DJ Euro Stoxx 50 (VGM0) is the European stock index contract, with stocks from all over Europe, including Portugal, Italy, Ireland, Greece, and Spain (PIIGS).
VGM0 is the lead stock index contract reacting to the EU situation and the Greek riots on live TV, and is generally extremely liquid (generally it is the second most liquid futures contract in the world).
Keep in mind that the underlying cash stock markets in Europe generally close between 11 and 12PM, so the underlying is not there to help stabilize this contract in times of stress, and this contract, though still quite liquid, is definitely less liquid during the U.S. afternoon.

On Thursday, within the trading world, the VGM0 was leading the way down across the stock and currency sectors after it peaked for the day around 0600ET.

At 14:44:50 VGM0 went offered down 260 at 2374 (almost 10% down on the day), which was either a pre-set price to stop trading or someone simply hit the BIG RED RESET BUTTON as the market immediately went into pre-open auction mode, and subsequently opened down an additional 40 points with an “opening auction” print of 2333 on 812 contracts. This was the low of the day for VGM0, which is somewhat common for such re-opening situations after a temporary closure during the trading day.
VGM0 didn’t trade for 107 seconds, it wasn’t locked limit down, it was resetting, preparing to re-open!

The S&P 500 contract (ESM0) was trading at 1086, down 6.70% at 14:44:50, and had been basically following VGM0 down, though it wasn’t down as much because the core of the current problem is European.
It then dropped 30 more points (down 9.28% on the day at the low) in 43 seconds to hit its 1056 low of the day at 14:45:33 a full 43 seconds after Europe’s main index had shut down temporarily.
It is interesting that the pre-opening indication for VGM0 started at 800 (!) and only stabilized above 2300 for the first time in the “mid-session pre-open” right at 14:45:33.

I could go into excruciating detail, but basically the Euro Stoxx Index led everything down all day, and when it started freefalling after 1400, and then shut down at 14:44:50, that is when our S&P contract completely
collapsed.

Another very key point is that EURJPY was already getting just crushed, and dropped 2% between 1400 and 1415 to get down 5% on the day, and then dropped another 2% between 14:43:00 and 14:46:00.

In terms of dollar volume, VGM0 is currently slightly less than ESM0 on volume.
For the first time in history VGM0 has the most liquidity (as we measure it) of any futures contract, as its volatility got pretty far ahead of the S&P last week.