Best of the Week
Most Popular
1. The Trump Stock Market Trap May Be Triggered - Barry_M_Ferguson
2.Why are Central Banks Buying Gold and Dumping Dollars? - Richard_Mills
3.US China War - Thucydides Trap and gold - Richard_Mills
4.Gold Price Trend Forcast to End September 2019 - Nadeem_Walayat
5.Money Saving Kids Gardening Growing Giant Sunflowers Summer Fun - Anika_Walayat
6.US Dollar Breakdown Begins, Gold Price to Bolt Higher - Jim_Willie_CB
7.INTEL (INTC) Stock Investing to Profit From AI Machine Learning Boom - Nadeem_Walayat
8.Will Google AI Kill Us? Man vs Machine Intelligence - N_Walayat
9.US Prepares for Currency War with China - Richard_Mills
10.Gold Price Epochal Breakout Will Not Be Negated by a Correction - Clive Maund
Last 7 days
JOHNSON AND JOHNSON - JNJ for Life Extension Pharma Stocks Investing - 17th Aug 19
Negative Bond Market Yields Tell A Story Of Shifting Economic Stock Market Leadership - 17th Aug 19
Is Stock Market About to Crash? Three Charts That Suggest It’s Possible - 17th Aug 19
It’s Time For Colombia To Dump The Peso - 17th Aug 19
Gold & Silver Stand Strong amid Stock Volatility & Falling Rates - 16th Aug 19
Gold Mining Stocks Q2’19 Fundamentals - 16th Aug 19
Silver, Transports, and Dow Jones Index At Targets – What Direct Next? - 16th Aug 19
When the US Bond Market Bubble Blows Up! - 16th Aug 19
Dark days are closing in on Apple - 16th Aug 19
Precious Metals Gone Wild! Reaching Initial Targets – Now What’s Next - 16th Aug 19
US Government Is Beholden To The Fed; And Vice-Versa - 15th Aug 19
GBP vs USD Forex Pair Swings Into Focus Amid Brexit Chaos - 15th Aug 19
US Negative Interest Rates Go Mainstream - With Some Glaring Omissions - 15th Aug 19
GOLD BULL RUN TREND ANALYSIS - 15th Aug 19
US Stock Market Could Fall 12% to 25% - 15th Aug 19
A Level Exam Results School Live Reaction Shock 2019! - 15th Aug 19
It's Time to Get Serious about Silver - 15th Aug 19
The EagleFX Beginners Guide – Financial Markets - 15th Aug 19
Central Banks Move To Keep The Global Markets Party Rolling – Part III - 14th Aug 19
You Have to Buy Bonds Even When Interest Rates Are Low - 14th Aug 19
Gold Near Term Risk is Increasing - 14th Aug 19
Installment Loans vs Personal Bank Loans - 14th Aug 19
ROCHE - RHHBY Life Extension Pharma Stocks Investing - 14th Aug 19
Gold Bulls Must Love the Hong Kong Protests - 14th Aug 19
Gold, Markets and Invasive Species - 14th Aug 19
Cannabis Stocks With Millennial Appeal - 14th Aug 19
August 19 (Crazy Ivan) Stock Market Event Only A Few Days Away - 13th Aug 19
This is the real move in gold and silver… it’s going to be multiyear - 13th Aug 19
Global Central Banks Kick Can Down The Road Again - 13th Aug 19
US Dollar Finally the Achillles Heel - 13th Aug 19
Financial Success Formula Failure - 13th Aug 19
How to Test Your Car Alternator with a Multimeter - 13th Aug 19
London Under Attack! Victoria Embankment Gardens Statues and Monuments - 13th Aug 19
More Stock Market Weakness Ahead - 12th Aug 19
Global Central Banks Move To Keep The Party Rolling Onward - 12th Aug 19
All Eyes On Copper - 12th Aug 19
History of Yield Curve Inversions and Gold - 12th Aug 19
Precious Metals Soar on Falling Yields, Currency Turmoil - 12th Aug 19
Why GraphQL? The Benefits Explained - 12th Aug 19
Is the Stock Market Making a V-shaped Recovery? - 11th Aug 19
Precious Metals and Stocks VIX Are About To Pull A “Crazy Ivan” - 11th Aug 19
Social Media Civil War - 11th Aug 19
Gold and the Bond Yield Continuum - 11th Aug 19
Traders: Which Markets Should You Trade? - 11th Aug 19
US Corporate Debt Is at Risk of a Flash Crash - 10th Aug 19
EURODOLLAR futures above 2016 highs: FED to cut over 100 bps quickly - 10th Aug 19
Market’s flight-to-safety: Should You Buy Stocks Now? - 10th Aug 19
The Cold, Hard Math Tells Netflix Stock Could Crash 70% - 10th Aug 19
Our Custom Index Charts Suggest Stock Markets Are In For A Wild Ride - 9th Aug 19
Bitcoin Price Triggers Ahead - 9th Aug 19
Walmart Is Coming for Amazon - 9th Aug 19

Market Oracle FREE Newsletter

Top AI Stocks Investing to Profit from the Machine Intelligence Mega-trend

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

© 2005-2019 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

6 Critical Money Making Rules