Furious bulls: how Wall Street became dependent on "high-speed" trades. Part 4

In March last year, the recently opened BATS Stock Exchange, located in Kansas City, organized its own initial public offering. But after a few seconds after the start of trading, something went wrong: a bug “froze” the trading of BATS shares on the BATS exchange itself and in the course of trading broke down the server responsible for all the tickers whose abbreviations began with the first letters the alphabet. Therefore, disabling the system had a negative impact on one company from Cupertino, the name of which begins with the letter “A”: because of it, the prices of the company's shares on the BATS exchange mistakenly began to be quoted at 10% below the real cost, which caused a brief halt of all trading shares of this company, one of the most famous in the world. [ The company with the letter “A” is Apple - approx. transl .]

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Meanwhile, the only stock exchange that quoted BATS shares was the Nasdaq, and weirdness also began with it. Within 900 milliseconds, too fast for anyone to react to this, BATS prices fell from $ 15.25 (price at the opening of the bidding) to $ 0.28, dropping to one-tenth of a cent before trading was suspended.

The executive directors of BATS apologized, claimed responsibility for the incident, stopped the IPO process and canceled the bidding. But perhaps something more has happened than just a system crash. Analyzing transactions, Nanex company engineer Jeffrey Donovan saw traces of the algorithm, designed to introduce stocks into the market with a consistent price reduction.

“Such an algorithm waits a few milliseconds after each transaction so that the offer price becomes lower than the price proposed by the algorithm, and then the cycle repeats until the share price is equal to zero,” he says.

Whoever was behind this, he was not going to cash in on this operation; Erik Scott Hunsader, CEO of Nanex, believes that this was an attempt to destroy BATS, which in just a few years took away 10% of the market volume of American trading from its well-established competitors.

High-frequency trading raises the existential question: Why do we need stock markets? Today, trading is becoming an end in itself.

BATS representatives did not comment on this theory, a rumor that went around all the stock exchanges last spring (the US Securities and Exchange Commission is studying this story). Other market observers were skeptical.

In general, as CEO of Tradeworx Manoj Narang says, “Computers do not become complicit in market manipulation. But people become. Any high-frequency trader who “sews up” manipulative logic into an algorithm for which they can be brought to court is probably too stupid to understand how they play on the stock exchange. ”

Most of Wall Street was looking for pluses. Since the fall of BATS did not provoke a crisis on other exchanges, many market observers believe that the rules introduced to prevent the “Flash Crash” from recurring (May 6, 2010). - when the Dow Jones Industrial Average fell by 600 points in five minutes, it still works. High-frequency traders believe that this event has misled the public, which is why they are now accused of every financial crisis since the Great Crash of 1929.

“People literally shake when they find out what I do,” says Irene Aldridge, lead algorithmic trader and panelist at the Battle of Quanta.

In a hundred-page report, regulators, avoiding the use of the words “fault” or “responsibility,” state that the disaster of 2010 began with the fact that “High-frequency traders began to quickly buy up and then resell contracts to each other - creating the effect of“ hot potatoes ”, since the same positions often fluctuated up and down. ” For those who monitor the state of their retirement account, this news is not good; in a little over two years since the moment of “Instant collapse,” investors managed to withdraw more than $ 300 billion from long-term mutual funds.

“When someone manages to sow panic because of a single bad deal, an unfavorable environment is created for investors,” says Themis Trading employee Sal Arnuk, “That's why they continue to leave the market to this day.”

High-frequency trading asks capitalism an existential question that most traders fear to face: What do we have stock markets for? The standard textbook answer is: to stimulate business investment by providing investors with guarantees that they can always sell their shares at the stated price - and this ensures the liquidity of their investments. From 1792 to 2006, the New York Stock Exchange was a non-profit quasi-organization owned by members of the exchange, brokers who traded on it.

Now it is a branch of a larger company NYSE Euronext, whose own profits and market price depend on whether high-frequency traders participate in the trades. Trading is becoming increasingly self-contained, separating from the part of the economy in which products and services are produced, and it is occupying an increasing part of GDP — twice as much as a hundred years ago when Wall Street financed rabid industrial growth.

“This is at least against common sense,” writes Thomas Philippon, an economist at New York University, in an article for the Russell Sage Foundation. “Why, then, does today's financial industry not exceed the financial industry of John Pierpont Morgan's times in efficiency?”

At a press conference several months ago, Mary Shapiro, chairman of the Securities and Exchange Commission, said she was concerned about the volume of trading "unrelated to the main characteristics of companies trading on exchanges." Methods were also proposed to abolish such a state of affairs, such as a proposal to punish traders for canceling too many teams. Most of these innovations remained at the level of proposals.

Automatic breakers impose restrictions on a gradual accelerating fall or rise in prices in the markets, but now high-frequency trading is essentially unregulated (now the Securities and Exchange Commission states that it will at least conduct an audit of trading operations occurring at a speed of microseconds - by purchasing access to Tradeworx data).

The fact that it reduces the cost of bidding and increases liquidity by reducing the spread between the purchase price and the sale price of a stock comes out in defense of automated trading.

“At the end of each trading day, stocks go into the hands of people who want to save them in the hope of increasing their value or paying dividends,” says Bernard Donefer at the Subotnick Financial Services Center at Im. Baruch City University of New York. “If you are one of these people, then you do not have to worry about what happens on the stock exchanges from 9:30 to 16:00 and you can safely feel the benefits of lowering the cost and increasing the speed of command execution.”

This, of course, is good, but, as Sal Arnuk and his coauthor Joseph Saluzzi noted in the book “Broken Markets,” you also bear the risk that stock prices will fluctuate in an unimaginable range if algorithmic traders stop using their programs to avoid their own losses. This is not a business where money will be earned for you.

To be continued …

PS The II All-Russian Conference on Algorithmic Trading will take place very soon. If you are interested in this topic - then here's an event on Habré , come, it will be interesting.