Best of the Week
Most Popular
1.North Korean Chinese Proxy vs US Military Empire Trending Towards Nuclear War! - Nadeem_Walayat
2.Researchers Find $10 Billion Hidden Treasure In A Dead Volcano - OilPrice_Com
3.Gold and Silver : The Battle for Control - Rambus_Chartology
4.Asda Sales Collapse and Profits Crash! UK Retailer Sector Crisis 2017 - Nadeem_Walayat
5.Deep State Conspiracy or Chaos - James_Quinn
6.The Stock Market Guns of August, Trade Set-Up & Removing your Rose Tinted Glasses - Plunger
7.Gold Stocks Coiled Spring - Zeal_LLC
8.Neil Howe: The Amazon-Walmart Rivalry Will Determine the Future of Retail - John_Mauldin
9.Crude Oil Price Precious Metals Link in August - Nadia_Simmons
10.Gold and Silver Precious Metals Nearing Breakout - Jordan_Roy_Byrne
Last 7 days
Global Financial Crisis 10 Years On: Gold Rises 100% from $650 to $1,300 - 23rd Aug 17
GBP/USD Extends Losses - 23rd Aug 17
Donald Trump Terrorist in Chief, “We Aren’t Nation-Building Again, We Are Killing Terrorists” - 23rd Aug 17
How Planned Fed Rate Increases Impact The National Debt & Deficits - 23rd Aug 17
The 3 Assets to Add to Your Stocks Portfolio in This Rate Tightening Cycle - 23rd Aug 17
Half Price UK Theme Parks Entry 2017 With Cheap Chocolate Packs - 23rd Aug 17
[GIFT] Market Control System! - 23rd Aug 17
4 Reasons European Stocks Will Make a Big Comeback This Year - 22nd Aug 17
3 Lesser-Known Charts Revealing a Massive Stock Market Disconnect - 22nd Aug 17
U.S. Treasury Secretary: "I Assume Fort Knox Gold Is Still There" - 22nd Aug 17
Is the Stock Market Setting itself up for a Spectacular Crash? - 22nd Aug 17
Power Elites Launches Civil War Against Trump - 22nd Aug 17
The Stock Market No Longer Cares About Trump - 21st Aug 17
The Coming Boom Of Productivity Will Get Our Economy Back On Track - 21st Aug 17
Buffett Sees Stock Market Crash Coming? His Cash Speaks Louder Than Words - 21st Aug 17
This Could Be The Biggest Gold Discovery In History - 21st Aug 17
Stock Market Correction in Full Swing - 21st Aug 17
Seeking Confirmations – US Stock Market - 21st Aug 17
The changing demographic of online gamblers - 21st Aug 17
Gold is a coiled spring… the breakout is here, fundamentals are in place, technicals are compelling - 20th Aug 17
A Midsummer Night's Dream: Buy Gold and Silver - 20th Aug 17
Gold Mining Stocks 2017 Fundamentals - 20th Aug 17
EIA Weekly Report and Crude Oil - 19th Aug 17
4 Insights for Adjusting Your Portfolio in a Rate-hike Environment - 19th Aug 17
Gold Direction Indicator - 19th Aug 17
Historical Inevitability and Gold and Silver Ownership - 19th Aug 17
You Are Being Lied To About “Low” Gold Demand - 19th Aug 17
This is Why Cocoa's Crash Was a Perfect Setup - 19th Aug 17
Gold, Silver Consolidate On Last Weeks Gains, Palladium Surges 36% YTD To 16 Year High - 19th Aug 17
North Korea Is Far From Being Irrational… It Has A Plan - 18th Aug 17
US Civil War - FUNCTIONAL ILLITERATES TRYING TO ERASE HISTORY - 18th Aug 17
Bitcoin Hits New All-Time High Over $4,400 As It Catches Paypal In Total Market Cap - 17th Aug 17
3 Psychological Ingredients behind Great Web Content - 17th Aug 17
The War on Cash - Rogoff, Orwell and Kafka - 17th Aug 17
The Stock Market Guns of August, Trade Set-Up & Removing your Rose Tinted Glasses - 16th Aug 17
Stocks, Bonds, Interest Rates, and Serbia, Camp Kotok 2017 - 16th Aug 17
U.S. Stock Market: Sunrise ... Sunset - 16th Aug 17

Market Oracle FREE Newsletter

3 Videos + 8 Charts = Opportunities You Need to See - Free

The Coming Stock Market Flash Crash

Stock-Markets / Financial Crash Oct 15, 2012 - 04:58 AM GMT

By: Money_Morning

Stock-Markets

Best Financial Markets Analysis ArticleShah Gilani writes: According to high-frequency traders and their backers, the super-fast, computer-driven stock trading desks that employ HFT are a benefit to investors and exchanges here in the U.S. and wherever they ply their trades.

But that's not true.

In fact, if you know exactly what high-frequency traders actually do and how they do it, you'll know what the SEC hasn't figured out, namely what caused the May 2010 Flash Crash.


You'll also realize that it's only a matter of time before these market manipulators cause a real catastrophic market crash.

Today I'll talk about what HFT players do and how they do it. And tomorrow I'll tell you how HFT could destroy our markets and economy.

What High-Frequency Traders Actually Do
High-frequency trading is fundamentally based on how market participants (for this discussion I'm talking about stock markets) place their orders to buy and sell shares and how HFT players act on those orders.

For every stock that's traded there is always (or at least it used to be "always") a "bid" and an "ask" price. Sometimes you'll hear the term "offer" or "offered" price, those terms are interchangeable with the term "ask" or "asking price."

The bid price is the price which someone is "bidding," or willing to pay to own shares. The ask price is the price which someone is willing to sell shares, or is "offering" or "asking" to sell at.

Bids and offers each come with the quantity of shares that the buyer or seller want to trade. There are millions of bids and offers made all day long, every trading day.

In fact, for every stock there are many bids and offers at several different prices.

The best bid, the highest price someone is willing to pay and how many shares they are willing to buy, and the best offered price, the lowest price at which someone is willing to sell their shares, constitutes a stock's current "quote."

In the U.S. we call that quote the NBBO, or national best bid and offer. But there are almost always other bids at lower prices and other offers at higher prices for all stocks.

High frequency traders employ pattern recognition algorithms that look deeply at bids and offers on stocks to determine if the movement on the bid quotes or offered quotes implies a directional tendency.

Computer-driven algorithms are "reading" the quotes, the intentions of buyers and sellers as they put down their orders in real-time, to make a trade that the HFT player expects to profit from if the directional bias their computers pick up is correct.

HFT computers look at all the bids and offers wherever any stock is traded. Sometimes stocks are traded at several different exchanges or "venues" at the same time.

But trading the price discrepancies that sometimes occur because there are different quotes at the same time at different exchanges for the same stocks isn't where HFT players make their money, although they do that, too.

What the HFT boys actually do more of than high frequency trading is "high frequency quoting."

They have their computers send out their own bids and offers, or quotes, to all the exchanges, almost all the time.

How HFT Manipulates Markets
What they are doing is trying to influence, I call it manipulate, what other traders and investors do with their bids and offers. They are trying to fake or set-up other market participants to react to the quotes the HFT players fire out onto the exchanges for all the stocks they trade.

Only the HFT quotes sent out aren't meant to be acted on. They aren't looking to buy on their bid quotes or sell on their offer quotes.

Instead, they are sending out orders to "ping" markets.

Ping refers to how sonar works. For example, a submarine sends out a sonar beep which hits a target and sends back a sound (which sounds like a ping) which the sonar operator "reads" to determine the pinged object's distance and shape.

HFT players are constantly pinging stocks where their quotes are housed and displayed. They send out their orders to manipulate others to adjust their quotes, which get fed into the HFT algorithms to determine any directionality; then, if an opportunity exists the HFT computers buy or sell shares that someone else has put onto the market.

They aren't quoting constantly as bona fide "market-makers" are supposed to do, which they claim they are acting like. They are simply putting out millions of fake bids and offers which they pull almost immediately, just to read the movement of other market participants who react to the HFT come-ons.

It isn't illegal. But it is manipulation.

The buyers and sellers the HFT crowd trades with aren't forced to trade, they are willing to trade -- it's just that the prices they trade at may have been manipulated.

High frequency trading accounts for at least 50% of all volume on America's 13 exchanges. The average number of shares traded daily at these exchanges is approximately 6.8 billion shares. The New York Stock Exchange's average daily share volume is about 1.6 billion shares.

HFT accounts for approximately 3.4 billion shares daily. But that's the low end of the estimates range.

Back in April 2010 when I first wrote about the dangers of HFT, I wrote "High-frequency trading (HFT) conducted by proprietary trading desks at big banks and private hedge funds accounted for 70% of equity trading volume in 2009, according to a paper released last month by the Federal Reserve Bank of Chicago."

Today estimates of HFT activity range from 50% of daily volume to as high as 78%.

That's what high frequency quoting and trading is. Mechanically, how it's done is another form of manipulation.

The Need For Speed
The whole game works on speed. HFT's high frequency quotes have to be able to reach their destination faster than everybody else's and they have to be able to cancel them just as fast, at least fast enough to not get them acted on, which is not what they want.

Once their pinging manipulates other players to move their quotes, the HFT computers have to be the fastest ones to get to the exchanges to buy and sell the shares they want. They do that sometimes, often enough, before the other players' computers have time to adjust their quotes or move out of the way.

How did the HFT crowd get so fast that they can make so much money off their slower counterparties?

They have an advantage because they pay the exchanges to place their servers (computer hardware) right next to the exchanges' servers at the exact locations where the exchanges' servers are housed.

How is that possible? It's easy, if not cheap.

For example, the NYSE built a 400,000 square foot data facility in Mahwah, NJ, just so they could rent server space to HFT outfits who wanted super-fast access to the Exchange's "matching engines."

That's right, the NYSE, which is overseen and regulated by the SEC, encourages HFT players to rent space from them so they can trade faster than everyone else who is supposed to have equal and fair access to trade on the New York Stock Exchange.

There's a huge difference in the time it takes for some players to place quotes and trade (huge can be as little as a few milliseconds) as opposed to those without the advantages that the HFT players pay for.

The term for the lag time it takes for the quote data to get from point A to point B in cyberspace (someone's server) is "latency."

Not being disadvantaged by latency is a huge boon to the HFT players. They can take advantage of tiny discrepancies in the bids and offers in the market that they help to set-up to profit from different prices, sometimes at different venues, but always where their speed advantage is a killer.

The pros call this "latency arbitrage." The TABB Group, a market data research firm, estimates that HFT desks make about $21 billion annually from latency arbitrage.

Obviously, there's a lot of money to be made in high frequency trading. And it's not illegal.

But it's not fair, either. And that's not even the problem with it.

The real problem with high frequency trading is that is has the potential to cause a catastrophic market crash.

Tomorrow, I'll tell you what the HFT crowd isn't doing that they say they are doing and what they are doing to potentially destroy our markets and the economy along with them.

Source :http://moneymorning.com/2012/10/15/the-truth-about-high-frequency-trading-and-the-coming-market-crash/

Money Morning/The Money Map Report

©2012 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive

© 2005-2017 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife