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High-Speed Trading Gains More Notoriety

By Rick Ackerman Posted on April 10, 2012, 5:51 am EDT Last Updated April 10, 2012, 7:57 am EDT

A story last week in the Wall Street Journal provided a fascinating glimpse into the world of high-speed, or “algo,” trading.  Who knew there was something called a “Hide Not Slide” order lurking in the murky shadows of  electronic trading?  Although this particular type of transaction might be difficult for the layman to understand, suffice it to say that it electronically hides or exposes bids and offers as needed with the skill of a three-card Monte hustler. The regulators supposedly are looking into algo trading because they suspect it might enable some traders to take unfair advantage of others. That would be putting it charitably – so much so that it is predictable that the SEC will detect a stench wherever they poke their noses, since it’ll be like sniffing out political corruption in Chicago during the Roaring Twenties. In the meantime, the Journal’s report on the probe in its early stages turned up stories that verged on the lurid, including one about a firm that advertised itself as a haven for big investors worried about getting picked off by algo traders. Turns out the firm, Pipeline Trading Systems, had an algo operation of its own called Milstream.

More than being merely suspicious about the way today’s electronic markets work is the BBC’s Max Keiser, a world-class muckraker who can smell financial scat a mile away.  In an interview we did with Max on Monday that will be linked here later this week, the discussion concerned some of the ways in which technological wizardry has helped tilt the playing field in favor of the trading world’s “one percent” elite. It may also turn out to have destabilized the markets so that a global flash crash is possible. We said as much in a recent commentary, and that is what drew Max’s attention. Do we actually believe this?  You bet. But even if we’re wrong, algorithm-driven trading has most surely supplanted what vestigial integrity remained in the game during the 1980s, when we worked as a market maker on the floor of the Pacific Coast Exchange. Traders shouted in each other’s faces and used hand signals to effect transactions in an “open outcry” system little changed from the open-air auctions held hundreds of years earlier beneath a buttonwood tree at the foot of Wall Street.  It wasn’t until the 1990s that rocket scientists took over the game. Writing for Barron’s in 1995, we lamented the change in an essay, The Way It Was, that described how the sun had set on options-trading cowboys.  The cowboys of the financial district may have represented a horrendous bottleneck in the world of globally networked trading, but it wouldn’t be a stretch to say that the game was more honest when humans still came face to face to trade in securities.

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  • Mark Uzick April 11, 2012, 4:47 am

    Rick: Camouflage trading, taught as part of the Hidden Pivot Course, puts us right on top of the lesser charts. I’ll let those who have taken the course vouch for my claim that it is easy to beat the machines. If anyone can devise a Trader vs. Deep Blue competition, I would welcome the chance to prove my point. RA
    —————————————————————–
    See my note above. Computers may beat the very best chess players, but I don’t think they can outwit a good technical trader. RA

    You seem to be contradicting your own thesis but you’re supporting mine.

  • Mark Uzick April 11, 2012, 4:36 am

    ebear: I can answer that. There are two elements to any analysis where human factors are involved. There’s the Event, and there’s Perception of the Event. If I perceive that I’m being gamed, then I’ll take my money elsewhere (in fact, I already have). I’m not waiting around for the scientific analysis that answers the question. It’s about managing uncertainty, and in the absence of knowledge I err on the side of caution.

    If you’re an investor – not a trader – then you can’t be gamed because you’re not in that game.

    If you’re a trader you need to be flexible; disruption and volatility create new opportunities but you need to be on your toes. (See Rick’s comments about how he can beat any supercomputers.) If you think you have the right to safely profit from some traditional forms of technical and automated trading, then think again; the world doesn’t owe you a living.

    If you’re an investor and all this scare talk has spooked you out of the market and into “safe” dollar denominated assets, then you’ve been gamed like a panicked herd of buffalo being run off a cliff have been gamed.

    • ebear April 11, 2012, 9:50 pm

      I think the distinction between investor and trader is largely artificial. Unless you’re actually starting (Gates) or buying (Warren) a company, both hold paper assets with an eye to selling them at some point. The only difference is the time horizon. I think the distinction between trader and gambler is more to the point. A good trader knows when to step off the boat, while a gambler just goes down with the ship.

      As I said, it’s all about managing risk – not just the risk inherent in a trade, which I fully understand and accept, but the risk of being blatantly ripped off (MF Global), having the rules changed in mid-game (Greek bonds vs the CDS), being pushed around by naked shorts (which is what HFT is when you strip away all the fancy talk) and any number of illegal, or unethical practices which go unregulated and unpunished. At least in Las Vegas I know the odds and can trust Nevada regulators to do their job. I have no such trust in Wall St, NY courts or D.C. so IMO, the only way to win nowadays is to not play.

      That doesn’t mean they’ve spooked me into the false security of some govt. backed paper either. Not at all. For example: I see a trend in shale exploration and have two choices. I can buy the stocks (and all the above risk that goes with that) or I can put a few trucks on the road and haul drill pipe to the Bakken. That’s the difference between an investor and a trader. I’ve done both, so I think I know.

      But I’d have to agree, The Cartel has done a remarkable job of stripping most “investors” of their wealth, first in stocks, then in housing, and soon to be in bonds. If you can make a living trading that, good luck. Myself, I’ll put my money to work where I have a better handle on the odds.

  • C.C. April 10, 2012, 7:37 pm

    Head spinning… Gawd I’m glad what I own I can hold in my hands. What to believe anymore? Guess I’m a throwback – but at least I can see and touch what I own.

  • Buster April 10, 2012, 5:41 pm

    ‘Get your ass & your assets out of Babylon if & whilst you still can, ‘cos she’s going down!’

    This is all part of the trend that is drying up the supply of sheeple which make the fraudulent operations of the Elitists function. When that happens, those in power who have sold us all out for a cut of the takings will see no further use for the ‘Empire of the City’ which has been managing the world for centuries through it’s three main tools; the financial debt system, the military/industrial complex & media/religion. The growing scrutiny of their operations by government is foreshadowing the eventual stripping of their assets & power.

    Tread very carefully, at the very least.

    • Cam Fitzgerald April 10, 2012, 11:27 pm

      You never even mentioned the media warping our thinking, the sex-in our faces every day, the electronic spying or the drugs and incarcerations, Buster. Those things are all part of the toolbox too as you no doubt know. They have been used very effectively for managing the population for decades. Everything is on the table during these days of great cynicism and fear. Little seems sacrosanct. I would not be surprised to see a movement return to some Orthodox and religiously based thinking in the coming years that may surprise as a new conservatism takes hold in America again. The liberalism of the past is a dead idea because it is what brought us to where we are. More of the same will not work. A return to more traditional values seems the obvious outcome to me and so that is what we should prepare for as time rolls on and the stresses of our past profligacy and waste come to haunt us all.

  • Bradley April 10, 2012, 5:17 pm

    GDXJ
    over and out

    • Bradley April 10, 2012, 6:39 pm

      If I were a better trader, I would have either been buying when I sold or not sitting on my hands now…

    • Rick Ackerman April 11, 2012, 12:10 am

      Not actually. I’ve lowered the stop-loss on our August 23.63 calls to 1.60, but they have yet to trade at the original stop, 1.65, even at yesterday’s fake-out low in the underlying.

  • Rich April 10, 2012, 4:41 pm

    Just sold SPY puts and bought calls…

    • gary leibowitz April 10, 2012, 6:05 pm

      I believe you are too early. The 1382 mark was breached. It could go easily to 1340 or 1320. Even if this is a normal retracement the move over the last few months has been large. I got in at 1270 so I will wait it out to see if 1320 holds.

    • gary leibowitz April 10, 2012, 10:02 pm

      Negate that. I am out. Now I wait to see if this thing stays within my zone. I expect the slow down overseas to help cool commodity prices but will it also cool overseas earnings? Notice that Oil is coming down just in time for the driving season. Not sure if it translates to the pump since refineries are near max. production now. It’s now all about overseas, not so much the domestic front.

    • Cam Fitzgerald April 10, 2012, 11:16 pm

      Major commodity cooling coming down the pipe, Gary. Troubles in China have put a chill on the markets and it is far from over as the stats come in over the coming months. Sell in May and go away really does have meaning this year. Glad most of you have finally acknowledged the truth of how a housing bust in China can adversely impact everything from Oil and Copper, Iron ore to Cement. It is not the end of the world of course. Even at 75% acceleration, China is incredibly dynamic and growing. We just need to keep it all in perspective as modest swings in consumption seem to result in overweight reactions in share values.

  • JoeJoe April 10, 2012, 4:21 pm

    One effect this algo trading has had on my trading is moving me away from charts of lesser degree. The shorter the time frame, the less fair it is to the individual trader.

    On long term charts, it is still a pretty fair game for the most part; you’ll have multiple opportunities to enter at a specified price level on most occasions.

    &&&&&

    Camouflage trading, taught as part of the Hidden Pivot Course, puts us right on top of the lesser charts. I’ll let those who have taken the course vouch for my claim that it is easy to beat the machines. If anyone can devise a Trader vs. Deep Blue competition, I would welcome the chance to prove my point. RA

    • Mark Uzick April 10, 2012, 8:10 pm

      I think you’re on to something: Spoofing can’t really affect the actions of human traders because it happens too quickly to be noticed, but it does outsmart slower or less sophisticated automatic trading systems, the most primitive of which are stop loss orders. This actually discourages those who find their stops regularly run from relying too much on them and forces them to make trading decisions more on fundamental valuations than technical gamesmanship. In other words, actions that introduce instability cause reactions that reduce complacency and increase stability. The very success of HFC automated systems leads to reactions that lead to diminishing returns for such systems and reduces over-reliance on trading systems that have historically triggered crashes.

    • Cam Fitzgerald April 10, 2012, 11:07 pm

      Nothing is easier to manipulate than technicals when you have the power of a supercomputer as the wind at your back. Technicals, by their nature, are subjected to these powerful machine forces each and every day because at their heart there is a basis in math. This is the realm of computers, not human beings and so no criticism is leveled at those who chart as a living. Just be aware of the real odds. We should also acknowledge that the formulas needed to defeat gold (for example) are amply available and that computer trading with the consent of the major buyers and sellers can manufacture any damn chart they want on a moments notice. Be aware, Gold can and will fall in price across the globe if the powers should choose to kill it. Indeed it will be killed so I would not bank on a great future in metals anymore.

      &&&&

      See my note above. Computers may beat the very best chess players, but I don’t think they can outwit a good technical trader. RA

  • Robert April 10, 2012, 3:44 pm

    “Traders shouted in each other’s faces and used hand signals to effect transactions in an “open outcry” system little changed from the open-air auctions held hundreds of years earlier beneath a buttonwood tree at the foot of Wall Street.”

    You nailed it right there- open outcry is still the basis of the world’s trading exchanges, yet this basis has been effectively neutered. The floor of the NYSE is silent these days.

    Look, when Exchanges let you plug your machines into their datacenters right next to their machines for a fee, they are selling competitive advantage.

    When you can stuff the bid and the ask with quotes that are deliberately intended to prevent honest bids from meeting honest asks, you are impeding the very transactions that underpin the free market.

    • Mark Uzick April 10, 2012, 8:43 pm

      Robert: When you can stuff the bid and the ask with quotes that are deliberately intended to prevent honest bids from meeting honest asks, you are impeding the very transactions that underpin the free market.

      I can see how it might trick other, less advantaged HFT systems from filling trades but I don’t see how it can affect trades between humans that are not relying on automatic trading strategies. The net effect may be to make trading more fundamental value and economic projection based than a test of technical gamesmanship and manipulation. It’s hard to successfully manipulate the market when there’s a smarter super-computer ready to take on all your tricks with smarter, faster tricks.

    • ebear April 10, 2012, 9:53 pm

      “I can see how it might trick other, less advantaged HFT systems from filling trades but I don’t see how it can affect trades between humans that are not relying on automatic trading strategies.”

      I can answer that. There are two elements to any analysis where human factors are involved. There’s the Event, and there’s Perception of the Event. If I perceive that I’m being gamed, then I’ll take my money elsewhere (in fact, I already have). I’m not waiting around for the scientific analysis that answers the question. It’s about managing uncertainty, and in the absence of knowledge I err on the side of caution.

      Now extrapolate. I’m nobody special. I’m not paid to play, I’m not too big to fail. I can walk anytime, to another market, to another line of business altogether. Now multiply that by all the girls and boys just like me who PERCEIVE that they’re being gamed and have learned to trust their perceptions. See what I mean?

    • ebear April 10, 2012, 10:12 pm

      I’ll just add one further thought. As every trader should know, change doesn’t come from above – it comes at the margin. Well, I am that margin. Now ask yourself, how much new money is coming in compared to old money that’s leaving? Jobs abundant are they? Everyone feeling flush? I know people who’ve been at this for years who’ve thrown in the towel. They don’t need to trade. They can get along just fine without it. So, who’s next?

    • Cam Fitzgerald April 10, 2012, 10:59 pm

      Incredibly, we may all one day demand an exchange that is for real traders only. Machines fully excluded. With the level of disgust expressed by so many here on this site (and elsewhere) it does appear that there is a niche to be exploited. A big niche, mind you. It is one that encompasses millions of traders the world over who are resigned to being beaten every day by computers and mathematical assignments of risk that simply cannot be managed by flesh and blood minds. If the game is really zero-sum then it is a certainty actual trades can only win by luck or inside knowledge. That is called gambling where I come from. Anyone out there want to start a new exchange? One that only permits trades for “the humans” amongst us?

  • John Jay April 10, 2012, 2:43 pm

    What I would like to know is what provisions of the tax code do they trade under? Do they submit endless Excel pages with each HFT showing cost basis and profit?
    Who checks that they document each trade? Even if they trade only 1256 type futures and options how can they possibly be audited by the IRS? Hedge Funds get the 15% rule right, maybe they all register as Hedge Funds.
    Nice to be a big player!

  • mac April 10, 2012, 2:36 pm

    well, I think something has been lost…my buy on breakouts worked back then…human stick-glue to stocks was stronger then…these computer bullet trades are too much, too fast, too inhuman! Yikes we gotta out trade them? Anyone think “sit tight and be right” can still work?

    • mario cavolo April 10, 2012, 4:16 pm

      I am utterly failing at it!!

  • FranSix April 10, 2012, 10:25 am

    High speed trading is just one facet in the trading scenario. High speed trading is necessary to carry out your risk-cartel controlled dynamic hedging strategy. 40X leverage is the other quite common aspect of commercial banking.

  • mario cavolo April 10, 2012, 7:24 am

    In fact, we are playing in a playing field where the rules are not the same for all players. I’m a guppy in a pool of sharks. Imagine we are playing American football and some guys get better, stronger, lighter equipment; shoulder pads, helmets, etc…..obviously not fair.

    • Mark Uzick April 10, 2012, 11:16 am

      Mario, if you were replying to me, I said that I’m not concerned about whether it’s fair, only whether it’s honest.

      The world isn’t fair: Some are stronger, some more talented, some smarter, some wealthier and some have better technology; you need to know your competition and try to find your own niche were you can compete without going head to head with the stronger players.

      There are some forms of unfairness that are caused by injustice: Fraud and abuse of power. I’m, of course, skeptical and suspicious of most institutions that have evolved in this morally corrupt society, but I’m not familiar enough with the inner workings of HFC to come to any conclusions – I need to hear more than just charges of unfairness as everyone tries to acquire an edge and those who succeed through their hard work and investment, as opposed to say bribery of officials to allow selective rule breaking for a favored few, deserve to profit from it.

    • Mario cavolo April 11, 2012, 12:04 am

      Hey Mark, reading the thread, spoofing sounds like the problem to me, a completely unethical practice that never should have been allowed in the first place if our understanding of itsnmechanics are right.

    • Mark Uzick April 11, 2012, 4:14 am

      Mario, I’m not convinced that spoofing is unethical but whether or not is is, like certain types of “insider trading”, I don’t believe it’s a problem for investors but maybe for some traders who’ve lost certain competitive advantages.

      Any time the comfortable and complacent are faced with disruptive technology that shakes them out of their slumber they’re going to gripe that “it’s not fair” and go running to the nanny state to “make it all stop!”.

  • Mark Uzick April 10, 2012, 7:06 am

    My only concern is whether there is not an unfair, but a fraudulent advantage given to some traders.

    Barring that, I don’t think this has much effect on long term investors, other than to give them occasional opportunities to establish long positions at bargain prices.

    For traders, volatility just makes things interesting – more danger and more potential profit. ( That’s assuming that some are merely being sucked in and outmaneuvered by superior strategy, not literally defrauded.)

    • BDTR April 10, 2012, 2:41 pm

      How can it not be predatorily ‘unfair’, Mark, utilizing the brightest MIT mathematicians writing algo’s trading in nano-seconds, ‘milking’ guaranteed profits by utterly controlling price direction with complete transparency of counter-party positions?

      It’s lunacy to think that anything other than sudden and total market implosion is restraining the slashing manipulation of applied advanced math married to the computational equivalent of a intergalactic starship operated by a collective, bankster Borg.

      If it ain’t phyzz it ain’t real anything anymore than a sucker-shell game of impoverishment at light-speed.

      Step-right-up, …or step back. Waaaay back.

    • fallingman April 10, 2012, 5:01 pm

      You make a good point. The manipulations can create bargains. That’s certainly happening in silver IMO.

      I guess the two important questions you have to answer are these:

      1) Is spoofing…the practice of pushing the market around with the use of phantom orders fraudulent?

      Maybe it is, maybe it’s not, but it sure as hell is sleazy. HFT undermines the integrity of the markets in a fundamental way. As Robert says below, ”
      When you can stuff the bid and the ask with quotes that are deliberately intended to prevent honest bids from meeting honest asks, you are impeding the very transactions that underpin the free market.” Exactly.

      What the market actually is now is not what it purports to be…or needs to be, which leads to the next question:

      2) Markets are supposed to function as price discovery mechanisms. They’re supposed to signal the level of legitimate buying and selling interest. Are they sending true signals now?

      I would say no. And when they don’t, it screws things up for all of us. The price mechanism is the way we efficiently balance supply and demand. Distortions abound at this point and we will all be paying the price for them.

      BDTR is right. It’s a sucker’s game, a shell game, and the fact is that many are stepping waaaay back. When you figure HFT volume is way up and overall volume is way down, the machines have largely taken over. And my guess is that the exodus of the humans hasn’t really started in earnest.

      The masters of the universe are destroying the integrity and legitimacy of the markets and I would argue that that is a big deal.

    • Mark Uzick April 10, 2012, 8:21 pm

      Fallingman, see my reply to JoeJoe below; it indirectly addresses some of your questions.

    • Cam Fitzgerald April 10, 2012, 8:33 pm

      Great points Fallingman. Price discovery is important when it can be relied upon as a true mechanism that anyone can use as a means of measure. Perhaps in the future what needs to happen is that computer driven HFT trades are only weighting 10% of valuations rather than being in complete control of the price discovery mechanism. In other words we would need to index individual stock issues to get a better appreciation of how they are really moving. Real world trades done by real people might then carry 90% or more of the weighting thus giving everyone a clearer idea of “human” interest or lack thereof. I know that idea is a little crackpot but how else can this problem be resolved. We are obviously headed into a day when individuals will simply stop participating in stock markets as they know they cannot outbid or beat supercomputers that are endowed with all the knowledge of history and understand how a million variables might impact each trade. People can not compete with that. Losing is therefore assured over time just as surely as gambling promises that if you play long enough you will eventually lose all your money. We will not get rid of these computers and Algo trades though. So why not slow the system and insist on costlier trades for machines? Why not even tax HFT trades. If the Wall street gangsters are going to steal and profit from Ma and Pa then it seems only fair that the government should take a heavy cut of the action to balance the system…….the other thing is this,..if the computers can buy and sell each share for a fee at a very, very small fraction of the cost of everyone else then why not either lower the cost for human traders or have the HFT’s and computers subsidize all normal trades. That, or raise the cost on HFT trades to make much less lucrative. There is no reason why a computer should be able to buy at a fraction of a penny and hold a stock for less than 20 seconds on average before dumping it at profit while the rest of us pay full fees and lose money.

  • SD1 April 10, 2012, 6:35 am

    Rightly or wrongly, we all contribute to it. We’re often trading tick charts looking for an edge.

    • fallingman April 10, 2012, 4:34 pm

      I get your point, and I would respectfully submit…it ain’t the same thing at all. This is not a question of trading vs. investing.

      To pick just one aspect, you’re talking about actually placing trades. That trading activity actually helps the market function by providing liquidity…keeps the bid asked spreads tighter.

      These algo guys are hustlers. Their game is mostly bluff. When you see a big takedown in the metals, that isn’t actual selling that starts the ball rolling.

      To borrow Ted Butler’s concise explanation of how takedowns are effected on the Comex metals exchanges:

      “The way HFT works is that the collusive trading programs suddenly flash great numbers of contracts for sale. But before much actual selling occurs, all the other traders in the market see the great volumes of contracts apparently offered for sale and these other traders withdraw buy orders and start entering their own sell orders to get ahead of the great wave of HFT sell orders offered. Then a not so funny thing happens. Most of the time, very few of the HFT orders originally offered for sale get filled or executed. Instead, they are quickly cancelled.
      There’s even an operative term for this practice that’s perfect – spoofing.”

      “Most of the HFT orders are never filled, nor are they ever intended to be filled. These spoof orders are intended to scare others into selling so that the dominant commercial traders can buy gold and silver contracts.”

      Spoofing…great…the Masters of The Universe would rather use trickery than take risk. In a way, you can’t blame them. Why does a dog…?

      Because he can!

    • Rich April 10, 2012, 4:40 pm

      Well put F-man.
      In the old days we called spoofing painting the tape.
      Illegal no matter how we slice and dice it…

    • Mario cavolo April 11, 2012, 12:00 am

      Well that sure as heck is what happened last night as we all got the nasty skakeout in pm’s before they reversed back where they were going in the first place! arghhh!!!


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