The defeat of robots: the ups and downs of high-frequency trading (Part 2)

[ First part ]

The decline in stock markets may to a certain extent be due to the fact that high-frequency trading discourages investors from investing in securities, which is especially noticeable after the May 6, 2010 event, called Flash Crash, when the decision to sell a large number of futures by computers caused a massive price collapse in the market. The Dow Jones Industrial Average fell 600 points in about 5 minutes. When the price spike occurred, most of the high-frequency traders who worked in the market that day became richer. And those whose cars did not work that day were accused of aiding the collapse and the lack of liquidity, as the fall accelerated due to the fact that relatively few high-speed traders were ready to buy stocks, the price of which was growing under the pressure of those who wanted to sell.

Over the next two years, Flash Crash was the greatest shame of high-speed traders. Then, last August [ article dated 2013 - approx. trans. ], the failure befell the company Knight Capital. Traders called this nightmare "the Knightmare." Until around 9:30 am on August 1, 2012, Knight could claim the title of the greatest HFT company and the largest trader in the US stock market. 17% of the volume of all trades on shares listed on the New York Stock Exchange and about 16% of trades on shares of companies from the Nasdaq listing passed through it.
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When the exchanges began their work on August 1, the new trading software, recently installed by Knight, went down and began to aggressively buy shares of 140 companies listed on the New York Stock Exchange. That morning, in about 45 minutes, Knight mistakenly acquired and sold shares worth $ 7 billion - at a rate of about $ 2.6 million per second. Each time after the purchase, the Knight algorithm raised the price at which he was ready to make a new purchase, and other firms were only too happy to offer him shares at this new price. At the end of the day on August 2, Knight lost $ 440 million, or about 40% of the amount that the company was valued before the incident.

Chicago-based Getco, one of the leading high-frequency market makers, has been swallowed Knight, which has remained among the fastest HFT companies for many years. However, there was probably nothing to compare Getco with: On April 15, Getco announced that its income had decreased by 90% over the past year. The company, which employed 409 people, earned only $ 16 million in 2012, incomparable with $ 163 million in 2011 and $ 430 million in 2008. Getco and Knight declined to comment on this story.

Getco problems say a lot about another trouble with high-frequency trading: they now pay much less for speed than before. Firms spend millions on the acquisition of millisecond benefits, constantly updating their fleet of computers and paying a lot of money to ensure that their servers are located as close as possible to the servers of the exchanges in large data centers. As soon as the exchanges realized how valuable milliseconds turned out to be, the amount of these fees went up. Rose and the cost of ribbons update quotes. During the time that firms spent millions trying to accelerate for a millisecond, the market itself accelerated, but not trader companies. And as a result, their profits fell.

“Speed ​​has become a mass phenomenon,” says Bernie Dan, CEO of Chicago-based Sun Trading, a large high-frequency market maker company.

No one knows this better than Steve Swenson. By the time he put Citi in 2010, there was a lot of competition in high-frequency trading. The more firms flooded the market with their high-speed algorithms that hunted for inefficiencies, the harder it became to make money on it - especially when trading volumes began to decline steadily since investors lost trust in stocks and began to invest more and more money in bonds. Svenson competed day by day with declining profits with hundreds of other high-speed traders who were just as fast and just as smart as he. In September 2012, TCV decided not to conduct a final round of investment. A month later, Svenson closed the project.

With a decrease in profitability and a reduction in the presence of HFT companies in the markets, regulators began to show an interest in what is happening. In January, Gregg Berman, a Princeton physicist who worked for the US Securities and Exchange Commission (SEC) since 2009, was promoted and headed by the newly created SEC Analytics and Research Department. His main task was to provide the Commission with information “from the first person” about what high-frequency traders actually do. Up to this point, the agency relied on the industry, and sometimes even on the financially-oriented blogosphere to understand the work of high-frequency trading. A few months after the events called Flash Crash, Berman met with representatives of dozens of trading companies, including high-frequency traders. He was amazed at how much data they were using, and how much their understanding of the markets was more accurate than their knowledge. He realized that he needed more high-precision systems and technologies — and that the easiest way to get them was from the high-frequency traders themselves.

Last fall, the SEC announced that it would pay $ 2.5 million to Tradeworx HFT for using its data collection systems to create a basic platform for a new market surveillance program. The system, codenamed Midas (Market Information Data Analytics System), researched market data from 13 US stock exchanges.
The Midas system began operation in February. With its help, SEC could now track abnormal situations in the market, like cheating quotes, and notice them before they appear on the Nanex and ZeroHedge blogs. If Midas noticed something strange, Berman’s team could take a closer look at the bidding information, study its millisecond within millisecond. The Midas system in the SEC was used by about 100 people, including the main group of quants, developers, programmers, and Berman himself.

“In the office, Gregg’s group is called the League of Distinguished Gentlemen,” said Brian Bussey, deputy director of the derivatives and trading practices department at the SEC, during the February panel discussion. “This group does not include lawyers, but current experts and market researchers.”

At that moment it was too early to say anything, but, apparently, Midas had already found evidence of a “dirty game.” In March, the Financial Times published information that the SEC transferred part of the FBI's data for further investigation of frauds in stock markets carried out by a number of HFT firms. The Commission declined to comment on this fact.

On March 12, the opening day of the annual meeting of representatives of the Futures Industry Association at the Boca Raton Resort & Club, employees of the Commodity Futures Trading Commission from the USA, Europe, Canada and Asia also organized a meeting behind closed doors. There was one question on the agenda: “Controlling the risks of high-frequency trading”.

Europeans have already tried to limit the possibilities of high-frequency traders. France and Italy have introduced a kind of tax on trading. In the European Commission began disputes about the introduction of a fee for conducting transactions in the territory of the Eurozone.

In the US, Bart Chilton, Commissioner for the Commodity Futures Trading Commission, discussed the possibility of imposing additional restrictions on traders. In the evening after the conference, sitting at a table on the hotel’s veranda, he explained his point of view. According to Chilton, the Commodity Futures Trading Commission has identified some "curious activity" in the markets that may "cause serious concern and be illegal." Chilton, calling high-frequency traders "cheetahs," believes that the Commission needs to reconsider its view of what it means by market manipulation.

According to the Commodity Futures Trading Commission standard, a market manipulating company must occupy a serious share of a market and be considered large enough to be able to manipulate. For example, a company that owns a 20% stake in a company can potentially manipulate this company. Since high-frequency traders rarely keep their positions unchanged for more than a few seconds, they only account for 1-2 percent of the market, but due to the tremendous impact of trading speed, they can often influence prices no less than their larger competitors - in particular, when what Chilton calls “food rabies” during an increase in volatility begins in their midst.

“We need to lower the bar so that cheetahs fall under it,” says Chilton. “The question is whether the revision of the standards will help track the cheetahs that manipulate the markets.”

Not long ago, the Commodity Futures Trading Commission introduced its own high-tech market surveillance system, able to track the traders' activity within a hundredth of a second and calculate which particular firm is holding the trade. This led to the Commission becoming interested in the potential fact of manipulation and “laundering” trading on the natural gas markets: the companies illegally traded with themselves to create a nonexistent boom.

In May, Chilton proposed a fee of 0.06 cents on futures trading and swaps. This tax should reduce activity in the markets, and the money raised can go to finance the Commission’s investigations. Democrats in Congress are ready to go further. Iowa State Senator Tom Harkin and Oregon State Representative Peter DeFazio want to introduce a fee of 0.03% of the amount of almost every transaction in most US markets.

With a decrease in profits, HFT companies are increasingly resorting to what is called "momentum-trading." Using methods similar to those that Swanson helped 25 years ago, momentum traders predict market movements and make large purchases / sales. Such a strategy can be profitable, but it carries enormous risks. Other high-frequency traders use sophisticated programs to analyze news feeds and titles of publications in an attempt to extract profit from it. Some even track Twitter feeds: a sudden market crash was evidence of this after a message about explosions in the White House was published on April 23 from the hacked Twitter account of the Associated Press. Probably, this is the only thing that remains for HFT companies.