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So What’s With the Market?

It seems the androids have taken over for real people. The terminator lives!!!!

Actually, that is much of the reason. Computer trading has replaced much of the trading that humans used to do. I’m going to cover a certain nefarious type that I really didn’t want to cover. I’ve known about it for a long time. Much like when I tackled the topic of Credit Default Swaps in 2006, I really didn’t want to try to explain it but I did. Sometimes there’s a limit to blood and gore.

Besides that, you don’t think the boys and girls “doing god’s work” had anything to do with it, do you? Find trouble in the financial markets and what name is sure to show up?

 High Frequency Trading

First of all, so you know, the amount of trading these cyber-freaks do is outrageous. This is according to the August 1, 2009 Wall Street Journal:

Also grabbing attention are the volume numbers. High-frequency trading now accounts for more than half of all stock-trading volume in the U.S. It also generates more revenue for exchanges. NYSE Euronext, owner of the New York Stock Exchange, is building a data center to cater to high-speed traders.

OK, so what is High Frequency Trading? The same article in the journal provided this:

Q: What is high-frequency trading?

A: Definitions differ, but at its most basic, high-frequency trading implies speed: Using supercomputers, firms make trades in a matter of microseconds, or one-millionth of a second. Goals vary. Some trading firms try to catch fleeting moves in everything from stocks to currencies to commodities. They hunt for "signals," such as the movement of interest rates, that indicate which way parts of the market may move in short periods. Some try to find ways to take advantage of subtle quirks in the infrastructure of trading.

Other firms are "market makers," providing securities on each side of a buy and sell order. Some firms trade on signals and make markets.

Now, let me explain in simple terms. Essentially it is legalized front running. If I front run, it is illegal. But when a computer does it… Front running is a simple concept. If I know there is going to be a massive amount of buy orders (or sell orders) for a certain stock, I place my order before the giant order is placed.

About last week’s market

Alan Abelson had this to say in today’s Barron’s:

In the vanguard of the tripping were "your friendly" high-frequency traders. To Sal and Joe [Sal Arnuk and Joe Saluzzi of Themis Trading], Thursday's market -- which was off at one time an awesome 9.2%, the biggest intraday plunge in all of recorded history (and probably unrecorded history as well) -- demonstrated clearly "the inherent and systemic risk of our automated stock market, with few checks and balances in place." And, they lament, "our market structure has evolved to cater to masters of expensive technology, deployed unfettered by participants whose only concern is to squeeze out every last picosecond and fractional cent."

Proponents of high-frequency trading, which these days accounts for between 50% and 70% of trading, never tire of citing as its supposedly incomparable virtue that it supplies gobs of liquidity to the market. It sorrows us to report that the bare bones of what happened on Thursday is that when the going got rough, the high-frequency crowd stampeded for the exits and their vaunted pools of liquidity vanished with them.

As the Themis pair describe the debacle, "once the market sensed stress, the bids were canceled and market sell orders chased prices down to the lowest possible point." Investors who had sought to protect themselves with the prudent use of stop orders got creamed because those orders were often filled at prices that were temporarily and wildly depressed.

Nor, Sal and Joe warn ominously, is this likely to prove an isolated incident; it will happen again. For the changed market structure, they contend, "at every turn sacrifices protection of long-term investor interests for the profitability of serving hyper-leveraged intraday speculators."

Barry Ritholtz has been writing about HFT for over a year now. Here is what he wrote on May 9:

HFT are like umbrellas on a sunny day. At the first sign of rain, they take their umbrellas back.

They have no market utility whatsoever — other than demonstrating the overwhelming corruption of the now publicly traded exchanges. They should not be for-profit companies, as their behavior demonstrates they are little more than whores and thieves.

I guess the commies were right — the capitalists will sell you the rope to hang them with . . .

On May 8, he wrote:

On Friday, I told a reporter that regardless of HFT’s role in the collapse, it is still a violent abrogation of the fiduciary duties owed to investors by stock exchanges. The NYSE has sold investors down the river in order to allow fee-paying, co-locating, black-box traders to profit unfairly at the expense ofevery other investor.

On September 18, 2009, he wrote:

The real question that remains unanswered and demands a thorough investigation is this: WHAT EXCHANGE OFFICIALS APPROVED THIS? WHO BELIEVED THAT ALLOWING FAVORED FIRMS TO FRONT RUN OTHER INVESTORS WAS OK?

Quite bluntly, the clueless dolts who allowed this to occur need to be publicly excoriated, fired from their job as exchange officials, and driven out of town on a rail. Oh, and, all the gains from this organized theft should be clawed back from all the front-running firms that stole this money — THAT’S RIGHT, ITS THEFT — one quarter cent at a time. Put the recovered ill-gotten gains into the SIPIC fund that compensates investors who have been defrauded by their stock brokers.

Stop for a moment to consider what sort of massive disregard for the investing public is required to permit this kind of trading. The sheer hubris that finds no problem in this exchange  encouraged theft is hard to fathom.

And guess who is benefiting!!! Who else?

You wouldn’t have guessed Goldman Sachs would you? As written in the July 23, New York Times:

Nearly everyone on Wall Street is wondering how hedge funds and large banks like Goldman Sachs are making so much money so soon after the financial system nearly collapsed. High-frequency trading is one answer.

And when a former Goldman Sachs programmer was accused this month of stealing secret computer codes — software that a federal prosecutor said could “manipulate markets in unfair ways” — it only added to the mystery. Goldman acknowledges that it profits from high-frequency trading, but disputes that it has an unfair advantage.

Yet high-frequency specialists clearly have an edge over typical traders, let alone ordinary investors. The Securities and Exchange Commission says it is examining certain aspects of the strategy.

“This is where all the money is getting made,” said William H. Donaldson, former chairman and chief executive of the New York Stock Exchange and today an adviser to a big hedge fund. “If an individual investor doesn’t have the means to keep up, they’re at a huge disadvantage.”

Here’s one that Ritholtz posted today. Keep in mind, whenever the market drops, Congress panics. We have plenty of evidence of that in the last 2 years. And when they panic they always cater to the banksters.

I don’t buy into the many conspiracy theories that continually seem to get resurrected, but I expect that this particular thesis, from Max Keiser, may very well have legs:

“May 6th was an unequivocal act of domestic financial terrorism in America. A day that will live in infamy.

To scare the lawmakers, themselves large owners of the very banks and stocks that they are supposed to be regulating, a financial Weapon of Mass Destruction was put to their head and they acquiesced.

As the inventor of the continuous double-action, market-making technology (VST tech. US pat. no. 5950176) that is referenced 132 times by program trading and HFT patents since 1996, I can tell you that Goldman, JP Morgan and the gang simply pulled the ‘buys’ from their computer trading programs and manufactured a crash. And when the coast was clear, and it was clear the politicians were not going to vote for anything that would break up the ‘too big to fail’ banks; all the ’sells’ were pulled from the computers and the market roared back.

This is a Manchurian Candidate market where program trading bots start the ball rolling in whatever direction Wall St. wants the market to go – and then hundreds of thousands of day-traders watching Cramer on CNBC jump on the momentum bandwagon and commit the crime for the Wall St. financial terrorists, who then say, ‘It wasn’t us, it was ‘the market!’”

Amped Content goes on to note that coincidentally the day after the crash, the “break up the too big to fail banks” amendment was soundly defeated by a 61 to 33 margin in Senate. And, a deal was struck to eliminate key provisions from the audit of the Federal Reserve bill. And, Goldman was meeting with the SEC to work out a settlement in their case against them.

I am always reluctant to put much stock into these nefarious “coincidences” — but I have to admit that Max’ theory here is quite intriguing . . .

table courtesy of ZeroHedge

 So what’s my take?

I just view it as another risk in the financial markets amongst all the other risks. It doesn’t affect my trading. As you know, I don’t use stop loss orders. For those that did I would imagine a large number of them got creamed. I tend to buy when things are out of favor so I doubt that HFT computers are taking a bite out of our trades. It certainly can lead to market volatility and I happen to like volatility. When the stock market is acting like a cd I can’t benefit to any great degree. I do think that HFT should be outlawed but then I think that many of the things that the TOO BIG TO FAIL BANKS can do should have been outlawed. Congress kisses up to those guys.

William Mason CFA