High frequency trading

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See also naked access and stub quotes.


Congressional oversight

Warner: 'Lack of oversight' contributed to stock freefall

Sen. Mark Warner (D-Va.) warned Thursday that a sudden stock market drop this afternoon was in part the product of a "lack of oversight."

Warner, who made millions by investing in technology and telecommunication, urged greater attention to high-frequency trading, errors in which the senator said had contributed to a drop of almost 1,000 points in the Dow Industrial average at one point today.

"Part of this precipitous drop seems that there was a technology glitch on an order that was put in that had no safeguard or backstop to prevent it," Warner said in a Senate floor speech. "I think we saw in real, breathing time today."

The market recovered most of the losses, which have been attributed by analysts to the fallout from the Greek debt crisis, but also reportedly an errant trade in which an individual trader entered "b" for "m" in "million" when trading Procter & Gamble shares today.

"This was not the result of a market, it was the result of, I believe, the lack of oversight," Warner said.

The Virginia senator urged including an examination of high-frequency trades in the financial reform legislation currently before the Senate.

"There was a warning sign shot across the bow today," Warner said.

Kaufman demands partial release of HFT "tagged" data

"...Today, Senator Ted Kaufman joins our pleas for full and transparent disclosure of all tagged HFT data. Alas, we are convinced that as long as the market is not allowed a down day by the primary dealers, any push for the SEC to do its job properly will be drowned out in the typical chorus of bullshit that the market is doing oh so well, and look just how much liquidity in Ambac and Citi there is... After all, that is all anybody trades these days.

Kaufman Says High Frequency Data Should Not Sit Unused - SEC should be an active regulator examining high frequency trading

WASHINGTON, DC. — Sen. Ted Kaufman (D-Del.) released the following statement today after the five Securities and Exchange Commissioners voted unanimously to adopt a proposed rule that should help regulators gain a better understanding of the complex and largely-opaque high frequency trading strategies that now dominate the equities markets:

“Today’s vote marks an important step to ensuring the Commission has the data it needs to analyze and understand high frequency trading strategies and detect any market abuses that illegally disadvantage long-term investors. ‘Large trader’ reporting, in conjunction with a consolidated audit trail, which three Commissioners discussed today, will substantially improve surveillance capabilities.

“But requiring broker-dealers to collect the data and the Commission examining it effectively are two different things. I want to learn more from the Commission about when and how they will analyze the ‘large trader’ data. We need active regulators and surveillance, not a passive system that permits data to pile-up in back offices.

“For that reason, I believe random samples of the data should be collected by the Commission and thoroughly analyzed, so that the Commission can say definitively that certain trading patterns – if the requisite element of intent can be shown – constitute illegal manipulation. Moreover, some of this data, in concealed form, should be released to the media and general public – or at least to academics and private analytic firms under ‘hold confidential’ agreements – so that independent analysts can assist the Commission in detecting illegal activity. If this requires new statutory language, I want to know that from the Commission so that I may push for the necessary changes.

“It is time to end the wild west environment in which high frequency trading firms are unbounded by effective surveillance and the possible detection of any manipulative trading strategies. This is a start, but much more needs to be done.”

The proposed rule would, for the first time, require high frequency firms that trade over 2 million shares or $20 million in a calendar day, or 20 million shares or $200 million during any calendar month, to self-identify and obtain a unique identification code. Broker-dealers would then use the ID code to track “large traders” and make the data available to the Commission on a next-day basis. The rule is being considered under the SEC’s existing “large trader” reporting authority.

In a Nov. 20 letter to Chairman Schapiro, Kaufman urged the Commission to move forward with a “large trader” reporting proposal and implement a consolidated audit trail, asserting, “we simply cannot permit high frequency practices to continue unchecked without the ability of regulators to observe and stop manipulation.” In her Dec. 3 response, Chairman Schapiro assured Kaufman that the Commission would soon put forth such a proposal in order to gain “better baseline information about high frequency traders and their trading activity.”

Kaufman requests review of market structure

"...The SEC’s review should be all-encompassing, reviving old ideas and examining new ones: should markets be centralised or decentralised; should we separate the markets based on investor types; what should be the role of market makers; what role might there be for real time risk management?

At a minimum, a few simple themes should guide us to a regulatory framework that permits vigorous competition while substantially reducing the possibility of a two-tiered trading network, where long-term investors are vulnerable to powerful trading companies that exist not to value or invest in the underlying companies, but to feed everywhere on small but statistically significant price differentials.

First, we should reconsider the criteria for becoming an exchange or market centre because the market’s unhealthy fragmentation – and the high-speed trading strategies that thrive on it – are growing rapidly.

Second, we should consider rule changes that ensure the best prices are publicly available, not hidden from view in private trades. The strength of a free market is based on this public display. Accordingly, we should reduce “internalisation” (by insisting on meaningful price improvement in comparison to the public quotes or by granting the public quotes the right to trade first) and trading in dark pools (by reducing the permissible threshold for dark trading and defining indications of interest, and other quote-like trading signals, as quotes).

Third, we should root out conflicts of interest by ending payments from market centres that encourage orders to flow their way. The search for best execution by broker-dealers should not be subject to temptation from the highest bidders. Competition for market share includes liquidity rebates and direct access for hedge funds, which also deserves careful review.

Fourth, until regulators can measure execution fairness in milliseconds for stock trades of all kinds, the credibility of the markets cannot be assured. The audit trails and records of order execution in fragmented venues must be synchronised to the millisecond and made readily available in statistically understandable formats to the regulators and the public. Currently, while high frequency traders bank profits in milliseconds, the first column for time on the Rule 605 form, used by regulators to measure execution quality, reads “0-9 seconds.”

Fifth, regulators must also develop more sophisticated statistical tests, such as following volume patterns to gain a granular view of gaming strategies. Only then can regulators separate high frequency strategies that add value to the marketplace from those that inexcusably take value away.

As a nation, our credit and equity markets should be a crown jewel. Only a year ago, we suffered a credit market debacle that led to devastating consequences for millions of Americans. While we must redress those problems, we must also urgently examine opaque and complex financial practices in other markets, including equities, before new problems arise. It is essential to ensure the integrity of US capital markets."

"Sen. Ted Kaufman (D., Del.) is expected on Monday to call for the Securities and Exchange Commission to review all forms of current stock-market structure, signaling the broadest statement yet from a legislator in the continuing debate over the growth in high-frequency trading, a lightning-fast, computer-based trading technique.

In a letter reviewed by Dow Jones Newswires to be sent to SEC Chairman Mary Schapiro on Monday, Mr. Kaufman said regulatory moves in the past decade have had the unintended consequence of making the stock market too fragmented, possibly giving high-speed traders an advantage over retail investors. Mr. Kaufman wrote that there are now a series of potential conflicts of interest on Wall Street trading desks trying to serve both retail clients and high-frequency firms.

"I request the SEC undertake a comprehensive, independent 'zero-based regulatory review' of a broad range of market-structure issues, analyzing current market structure from the ground up before piecemeal changes built on the current structure increase the potential for execution unfairness," wrote Mr. Kaufman. In a zero-based regulatory review, each part of the current market structure would be reviewed comprehensively, as opposed to a traditional review of one particular type of market structure."

  • Battle Over High-Frequency Trades Bloomberg News video (running time 1 minute) Senator Kaufman proposes broad based study of market structure to the SEC, Aug. 24, 2009.

Kaufman proposes banning "flash trading"

Source: A Level Playing Field for Investors Real Clear Markets, July 31, 2009

"... Third, the SEC should ban the use of so-called "flash orders" by high-frequency traders. Flash orders allow exchange members who pay a fee to get a first look at share order flows before the general public. By viewing this buy and sell order information for just milliseconds before it goes to the wider market, these investors gain an unfair advantage over the rest.

As the New York Stock Exchange complained to the SEC on May 28, selling flash orders for a fee provides "non-public order information to a select class of market participants at the expense of a free and open market system." To use a baseball metaphor, flash orders allow some batters to pay to see the catcher's signals to the pitcher, while the rest of us don't see them. Markets that permit a privileged few to have special access to information cannot maintain their credibility.

Amazingly, it is a loophole in current regulations that allows this unfair practice. This can and should be fixed immediately..."

Post] ZeroHedge, July 25, 2009

Schumer proposes banning "flash trading"

Source: Schumer Presses SEC for Ban on ‘Unfair’ High-Frequency Trades Bloomberg, July 25, 2009

"Charles Schumer, the third-ranking Democrat in the U.S. Senate, asked the Securities and Exchange Commission to ban so-called flash orders for stocks, saying they give high-speed traders an unfair advantage.

Schumer’s letter to SEC Chairman Mary Schapiro yesterday raised the stakes in a debate over the practice offered by Nasdaq OMX Group Inc., Bats Global Markets and Direct Edge Holdings LLC, which handle more than two-thirds of the shares traded in the U.S. With flash orders, exchanges wait up to half a second before they publish bids and offers on competing platforms, giving their own customers an opportunity to gauge demand before other traders.

“This kind of unfair access seriously compromises the integrity of our markets and creates a two-tiered system, where a privileged group of insiders receives preferential treatment,” Schumer wrote in the letter.

Flash orders make up less than 4 percent of U.S. stock trading, according to Direct Edge and Bats. They have drawn criticism from the Securities Industry and Financial Markets Association, which is Wall Street’s main lobbying group, and Getco LLC, one of the biggest firms that uses high-frequency trading strategies to make markets in stocks and options. NYSE Euronext, owner of the world’s largest exchange by the value of companies it lists, told the SEC in May that the technique results in investors getting worse prices.

Schumer, a member of the Senate Banking Committee, said he will introduce legislation to ban flash orders if the SEC doesn’t act on his request..."

Senator Schumer's letter to SEC Chairman Shapiro July 24, 2009

NASDAQ and BATS to stop flash trading

Source: NASDAQ and BATS to stop flash trading FT Alphaville, August 6, 2009

"The war on high frequency trading continues apace - and already there have been some high-profile casualties, or at the very least, capitulations.

Both Nasdaq and BATS said on Thursday they will stop offering flash trading - mere months after they initiated the service on June 3."

SEC oversight

SEC bans 'naked access'

The Securities and Exchange Commission voted on Wednesday to bar brokers from granting high-frequency traders unfiltered access to an exchange, a move aimed at imposing safeguards meant to prevent bad trades from disrupting the markets.

"Naked access" lets high-speed traders and others buy and sell stocks on exchanges using a broker's computer code without requiring them to filter through the broker's systems or undergo any pretrade checks.

Such trading arrangements have exploded with the growth of high-frequency trading firms, which rely on trading speed to make their money and don't want to be bogged down by a broker's controls. In some cases, brokers rely on assurances from traders that they have their own controls in place. Roughly 30% of market activity is currently conducted through naked access, said John Jacobs, director of operations at Lime Brokerage.

SEC & CFTC Staff report on May 6 "flash crash"

On May 6, 2010, the prices of many U.S.-based equity products experienced an extraordinarily rapid decline and recovery. That afternoon, major equity indices in both the futures and securities markets, each already down over 4% from their prior-day close, suddenly plummeted a further 5-6% in a matter of minutes before rebounding almost as quickly.

Many of the almost 8,000 individual equity securities and exchange traded funds (“ETFs”) traded that day suffered similar price declines and reversals within a short period of time, falling 5%, 10% or even 15% before recovering most, if not all, of their losses.

However, some equities experienced even more severe price moves, both up and down. Over 20,000 trades across more than 300 securities were executed at prices more than 60% away from their values just moments before. Moreover, many of these trades were executed at prices of a penny or less, or as high as $100,000, before prices of those securities returned to their “pre-crash” levels.

By the end of the day, major futures and equities indices “recovered” to close at losses of about 3% from the prior day...

...The second liquidity crisis occurred in the equities markets at about 2:45 p.m. Based on interviews with a variety of large market participants, automated trading systems used by many liquidity providers temporarily paused in reaction to the sudden price declines observed during the first liquidity crisis. These built-in pauses are designed to prevent automated systems from trading when prices move beyond pre-defined thresholds in order to allow traders and risk managers to fully assess market conditions before trading is resumed.

After their trading systems were automatically paused, individual market participants had to assess the risks associated with continuing their trading. Participants reported that these assessments included the following factors:

  • whether observed severe price moves could be an artifact of erroneous data;
  • the impact of such moves on risk and position limits;
  • impacts on intraday profit and loss (“P&L”);
  • the potential for trades to be broken, leaving their firms inadvertently long or short on one side of the market;
  • and the ability of their systems to handle the very high volume of trades and orders they were processing that day.

In addition, a number of participants reported that because prices simultaneously fell across many types of securities, they feared the occurrence of a cataclysmic event of which they were not yet aware, and that their strategies were not designed to handle.10

Based on their respective individual risk assessments, some market makers and other liquidity providers widened their quote spreads, others reduced offered liquidity, and a significant number withdrew completely from the markets. Some fell back to manual trading but had to limit their focus to only a subset of securities as they were not able to keep up with the nearly ten-fold increase in volume that occurred as prices in many securities rapidly declined.

HFTs in the equity markets, who normally both provide and take liquidity as part of their strategies, traded proportionally more as volume increased, and overall were net sellers in the rapidly declining broad market along with most other participants. Some of these firms continued to trade as the broad indices began to recover and individual securities started to experience severe price dislocations, whereas others reduced or halted trading completely.

Many over-the-counter (“OTC”) market makers who would otherwise internally execute as principal a significant fraction of the buy and sell orders they receive from retail customers (i.e., “internalizers”) began routing most, if not all, of these orders directly to the public exchanges where they competed with other orders for immediately available, but dwindling, liquidity.

SEC proposes consolidated audit trail

The Commission preliminarily believes that with today’s electronic, interconnected markets, there is a heightened need for regulators to have efficient access to a more robust and effective cross-market order and execution tracking system.

Currently, many of the national securities exchanges and the Financial Industry Regulatory Authority, Inc. (“FINRA”) have audit trail rules and systems to track information relating to orders received and executed, or otherwise handled, in their respective markets.

While the information gathered from these audit trail systems aids the SRO and Commission staff in their regulatory responsibility to surveil for compliance with SRO rules and the federal securities laws and regulations, the Commission preliminarily believes that existing audit trails are limited in their scope and effectiveness in varying ways.

In addition, while the SRO and Commission staff also currently receive information about orders or trades through the electronic bluesheet (“EBS”) system, Rule 17a-25 under the Exchange Act,1 or from equity cleared reports, the information is limited, to varying degrees, in detail and scope.

Comments on the Proposed Rule due August 9, 2010.

SEC new stock-by-stock circuit breaker rules

The Securities and Exchange Commission today approved rules that will require the exchanges and FINRA to pause trading in certain individual stocks if the price moves 10 percent or more in a five-minute period. The rules, which were proposed by the national securities exchanges and FINRA and published for public comment, come in response to the market disruption of May 6.

Additional Materials

The SEC anticipates that the exchanges and FINRA will begin implementing the newly-adopted rules as early as Friday, June 11.

"The May 6 market disruption illustrated a sudden, but temporary, breakdown in the market's price setting function when a number of stocks and ETFs were executed at clearly irrational prices," said SEC Chairman Mary Schapiro, who convened a meeting of the exchange leaders and FINRA at the SEC following the market disruption. "By establishing a set of circuit breakers that uniformly pauses trading in a given security across all venues, these new rules will ensure that all markets pause simultaneously and provide time for buyers and sellers to trade at rational prices."

Under the rules, trading in a stock would pause across U.S. equity markets for a five-minute period in the event that the stock experiences a 10 percent change in price over the preceding five minutes. The pause, which would apply to stocks in the S&P 500® Index, would give the markets the opportunity to attract new trading interest in an affected stock, establish a reasonable market price, and resume trading in a fair and orderly fashion. Initially, these new rules would be in effect on a pilot basis through Dec. 10, 2010.

The markets will use the pilot period to make appropriate adjustments to the parameters or operation of the circuit breakers as warranted based on their experience, and to expand the scope to securities beyond the S&P 500 (including ETFs) as soon as practicable.

"It is my hope to rapidly expand the program to thousands of additional publicly traded companies," added Chairman Schapiro.

At Chairman Schapiro's request, the SEC staff also will:

  • Consider ways to address the risks of market orders and their potential to contribute to sudden price moves.
  • Consider steps to deter or prohibit the use by market makers of "stub" quotes, which are not intended to indicate actual trading interest.
  • Study the impact of other trading protocols at the exchanges, including the use of trading pauses and self-help rules.
  • Continue to work with the exchanges and FINRA to improve the process for breaking erroneous trades, by assuring speed and consistency across markets.

The SEC staff is working with the markets to consider recalibrating market-wide circuit breakers currently on the books — none of which were triggered on May 6. These circuit breakers apply across all equity trading venues and the futures markets.

SEC HFT roundtable - June 3, 2010

Some fast-moving computer-driven investment firms are getting an edge by trading on market data before it gets to other investors, according to market players and researchers who have studied the trading.

The firms gain that advantage by buying data from stock exchanges and feeding it into supercomputers that calculate stock prices a fraction of a second before most other investors see the numbers. That lets these traders shave pennies per share from trades, which when multiplied by thousands of trades can earn the firms big profits.

Critics all the practice the modern day equivalent of looking at share prices listed in tomorrow's newspaper stock tables today.

"It is a rigged game," Sal Arnuk, co-founder of brokerage firm Themis Trading, said Wednesday at a Securities and Exchange Commission roundtable discussion in Washington, D.C., referring to the trading activity, which some call "latency arbitrage."

While legal, the practice pushes the envelope of what is fair, critics say, and raises questions about the advantages some fast-moving traders are gaining in the market.

The SEC roundtable convened executives from trading centers and firms across Wall Street as the agency continues to probe high-frequency trading and the growth of dark pools, trading venues where trades take place away from the main exchanges.

High-frequency trading has come under greater scrutiny since the May 6 "flash crash," when some high-frequency firms along with a number of other active traders withdrew from the market, arguably exacerbating the stocks' swift downdraft that day.

High-speed trading, now estimated to account for about two-thirds of U.S. stock market volume, takes many forms, some entirely proper. Defenders say it reduces trading costs for all investors by adding volume to the market. Latency arbitrage is a type of trading that relies on ultrahigh speeds; it's not clear which firms engage in it or how pervasive it is.

Some firms pay tens of thousands of dollars a year to individual exchanges for premium access to their price feeds, industry players and exchanges say.

The SEC, in a broad review of market structure earlier this year, said information from trading-center data feeds "can reach end-users faster than the consolidated data feeds."

The latency arbitrage trade aims to game the so-called national best bid and offer price on a stock, which sets the price most investors use to trade.

The ability to estimate price moves ahead of the national best bid and offer price, which is consolidated electronically from exchanges, can give traders an advantage of about 100 to 200 milliseconds over investors who use standard market tools, according to a November 2009 report on such trading activities by Jefferies & Co.

An advanced look at exchange data and order flow can provide firms "the ability to forecast future prices" and "make adjustments to their orders in the market or send new orders which are based on this information," the report found.

Some investors are searching for ways to protect themselves. Rich Gates, co-founder of TFS Capital LLC, started becoming concerned about latency arbitrage in early 2009 after a Wall Street bank pitched the trade to his firm.

In hundreds of tests, TFS has found that some of its trades were getting picked off by firms exploiting the time-delay wrinkle. That was costing the firm money.

To learn more, TFS, which manages about $1.1 billion in mutual funds and hedge funds, devised a method to essentially bait firms into engaging in the trade. In effect, TFS proved that some traders were wise to a movement in a stock's price before it happened.

On a March afternoon, a TFS trader sent an order to a broker to buy shares of Nordson Corp., a maker of fluid dispensing equipment. The trader sent an instant message to the broker: "please route to broker pool #2," a request to send the order to a specific dark pool.

The trader told the broker not to pay a price higher than the midpoint between what buyers and sellers were offering, which at the time was $70.49.

Several seconds after the dark pool order was placed, the market price didn't change. Then the TFS trader set a trap: he sent a separate order into the broader market to sell Nordson for a price that pushed the midpoint price down to $70.47.

Almost immediately, TFS was sold Nordson for $70.49—the old, higher midpoint—in broker pool No. 2, which didn't reflect the new sell order. TFS got stuck paying two cents more than it should have, suggesting that some seller knew the higher price was a good deal to nab quickly.

Such trades are "unusually suspicious," said Mr. Gates.

Most dark pool operators say they police investors for improper activities. Liquidnet, which runs a dark pool, had suspended 125 members through 2009 for suspicious trading since its launch in April 2001, the firm says.

Preliminary findings regarding trading on May 6, 2010


On May 6, 2010, the financial markets experienced a brief but severe drop in prices, falling more than 5% in a matter of minutes, only to recover a short time later. Since that day, the staffs of the Securities and Exchange Commission and the Commodity Futures Trading Commission have been collecting and reviewing massive amounts of information in order to understand the events and to recommend appropriate measures.


Preliminary Findings

May 6 started with unsettling political and economic news from overseas concerning the European debt crisis that led to growing uncertainty in the financial markets. Increased uncertainty during the day is corroborated by various market data: high volatility; a flight to quality among investors; and the increase in premiums for buying protection against default by the Greek government. This led to a significant, but not extraordinary, down day in early trading for the securities and futures markets. Beginning shortly after 2:30 p.m.,2 however, this overall decline in the financial markets suddenly accelerated. Within a matter of a few minutes, there was an additional decline of more than five percent in both the equity and futures markets. This rapid decline was followed by a similarly rapid recovery. This extreme volatility in the markets suggests the occurrence of a temporary breakdown in the supply of liquidity across the markets.

The decline and rebound of prices in major market indexes and individual securities on May 6 was unprecedented in its speed and scope. The whipsawing prices resulted in investors selling at losses during the decline and undermined confidence in the markets. Although evidence concerning the behavior of the financial markets on May 6, 2010 continues to be collected and reviewed, a preliminary picture is beginning to emerge.

At this point, we are focusing on the following working hypotheses and findings–

  1. possible linkage between the precipitous decline in the prices of stock index products such as index ETFs and the E-mini S&P 500 futures, on the one hand, and simultaneous and subsequent waves of selling in individual securities, on the other, and the extent to which activity in one market may have led the others;
  2. a generalized severe mismatch in liquidity, as evinced by sharply lower trading prices and possibly exacerbated by the withdrawal of liquidity by electronic market makers and the use of market orders, including automated stop-loss market orders designed to protect gains in recent market advances;
  3. the extent to which the liquidity mismatch may have been exacerbated by disparate trading conventions among various exchanges, whereby trading was slowed in one venue, while continuing as normal in another;
  4. the need to examine the use of “stub quotes”, which are designed to technically meet a requirement to provide a “two sided quote” but are at such low or high prices that they are not intended to be executed;
  5. the use of market orders, stop loss market orders and stop loss limit orders that, when coupled with sharp declines in prices, for both equity and futures markets, might have contributed to market instability and a temporary breakdown in orderly trading; and
  6. the impact on Exchange Traded Funds (ETFs), which suffered a disproportionate number of broken trades relative to other securities.

We have found no evidence that these events were triggered by “fat finger” errors, computer hacking, or terrorist activity, although we cannot completely rule out these possibilities.

Key Avenues for Further Investigation

Much work is needed to determine all of the causes of the market disruption on May 6. At this stage, however, there are a number of key themes that we are investigating.

Futures and Cash Market Linkages. The first relates to the linkages between trading in equity index products, including stock index futures and the equity markets. About 250 executing firms processed transactions for thousands of accounts during the hour 2:00 p.m. – 3:00 p.m. in the E-Mini S&P 500 futures contract. Of these accounts, CFTC staff has more closely focused their examination to date on the top ten largest longs and top ten shorts. The vast majority of these traders traded on both sides of the market, meaning they both bought and sold during that period. One of these accounts was using the E-Mini S&P 500 contract to hedge and only entered orders to sell. That trader entered the market at around 2:32 and finished trading by around 2:51. The trader had a short futures position that represented on average nine percent of the volume traded during that period. The trader sold on the way down and continued to do so even as the price level recovered.

Data from the CME order book indicates that, although trading volume in E-mini S&P 500 futures was very high on May 6, there were many more sell orders than there were buy orders from 2:30 p.m. to 2:45 p.m. The data also indicate that the bid ask spread widened significantly at or about 2:45 p.m. and that certain active traders partially withdrew from the market. Considerable selling pressure at this vulnerable period in time may have contributed to declining prices in the E-Mini S&P 500 – and other equivalent products such as the SPY (an ETF that tracks the S&P 500).

All of these markets are closely linked by a complex web of traders and trading strategies. The precipitous decline in price in one market on May 6 may have influenced a sustained series of selling in other financial markets. The rapid rebound in price in one market could similarly have been linked to a rebound in price in another.

Implications for the Equity Markets. The great majority of securities experienced declines that are generally consistent with the decline in value of the large indexes. Some were less than the approximately 5% decline in the E-mini S&P 500 during that period, and some were greater. Approximately 86% of securities, however, reached lows for the day that were less than 10% away from the 2:40 p.m. price.

The other 14% of securities suffered greater declines than the broader market, with some trading all the way down to one penny. The experience of these securities exposed potential weaknesses in the structure of the securities markets that must be addressed. One hypothesis as to why the prices of some securities declined by abnormally large amounts on May 6 is that they were affected by disparate practices among securities exchanges. In the U.S. securities market structure, many different trading venues, including multiple exchanges, alternative trading systems and broker-dealers all trade the same stocks simultaneously. Disparate practices potentially could have hampered linkages among these trading venues and led to fragmented trading in some securities. Two types of disparate practices on May 6 relate to the NYSE’s liquidity replenishment points (“LRPs”) and the self-help remedy in Regulation NMS. These and other practices merit significant ongoing review:

● LRPs and Similar Practices. The NYSE’s trading system incorporates LRPs that are intended to dampen volatility. When an LRP is triggered, trading on the NYSE will “go slow” and pause for a time to allow additional liquidity to enter the market. Some have suggested that LRPs actually exacerbated, rather than dampened, price volatility on May 6 by causing a net loss of liquidity, as orders were routed to other trading venues for immediate execution rather than waiting on the LRP mechanism. If this occurred, it potentially could have caused some NYSE securities to decline further. 


Major exchanges agree in principle to new e-trading rules

The leaders for major securities exchanges have agreed in principle to a uniform system of "circuit breakers" that would slow trading during periods of intense market volatility, Federal regulators said Monday.

The heads of the biggest exchanges "agreed on a structural framework, to be refined over the next day," Securities and Exchange Commission Chairman Mary Schapiro said.

The agreement has been reached by leaders of six exchanges, including the New York Stock Exchange and NASDAQ.

The absence of a uniform system is being looked at as a possible trigger for last week's historic stock market plunge.

In an effort to calm Thursday's rapid market swings, the New York Stock Exchange invoked a measure to slow trading. Some analysts believe that drove trades onto other electronic exchanges, which didn't slow trading. That left fewer buyers and sellers to help set prices, potentially accelerating Thursday's drop.

SEC votes unanimously to tag HFT traders

We are happy that one year after starting our campaign against the complete travesty to market efficiency that is HFT (yes, they frontrun and scalp and subpenny and generate artificial momentum, but they bring liquidity!.... in five bankrupt stocks while raising slippage costs everywhere else) the SEC has realized that there is so much more than meets the eye, and that no matter how many conflicted Op-Eds are publish in Advanced Trader, that will not change the nature of what HFT is.

At a meeting today, the Securities and Exchange Commission voted unanimously for a plan to tag high-frequency traders with ID numbers and give the SEC access to information on their trades.

Branding sure is an appropriate act for all these parasitic market participants. Hopefully the SEC will tear itself away from the terabytes of kiddie and tranny porn available on the internet to actually analyze and compile the data it receives (we realize that releasing it to the public would be far too much in keeping with Obama's initial and soon forgotten promise of unprecedented transparency), instead of just dumping it in the shredder as it has done in the past with Madoff, with Greenspan, and with other masters of the ponzimonium.

From Reuters:

The SEC is already examining whether additional rules are needed to curb fast traders, or firms that use sophisticated algorithms to buy and sell stock in a fraction of a second.

The rapid trading is estimated to account for some 60 percent of all U.S. equity trading. The proposed rules would apply to 400 of the largest traders operating in the U.S. equity markets. Traders would be tagged if they trade at least 2 million shares or $20 million during a day.

"To better oversee the U.S. securities markets, the commission must be able to readily identify large traders operating in the ... markets, and obtain basic identifying information on each large trader, its accounts, and its affiliates," SEC Chairman Mary Schapiro said.

At the same meeting, the SEC will consider proposals to ensure investors have fair access to the options markets. Currently there are eight U.S. options exchanges that charge investors different fees to access their markets.

The SEC is considering capping the fee at 30 cents per contract.

SEC issues "concept release" on HFT

The Securities and Exchange Commission voted to propose banning brokers from providing clients with unsupervised access to stock exchanges, a practice that accounts for about two of every five shares that trade in the U.S.

Chairman Mary Schapiro said so-called naked sponsored access, in which a customer bypasses the pre-trade controls of his broker and accesses exchanges directly, may expose the market and firms that offer the service to too much risk.

“We are concerned that order-entry errors in this setting could suddenly and significantly make a broker-dealer or other market participants financially vulnerable within mere minutes or seconds,” Schapiro said at a hearing in Washington today.

Commissioners met today to begin formulating the next round of stock market regulation, focusing on strategies used by professional investors, such as sponsored access, and “dark pool” trading venues. The agency voted 5-0 to approve the market-access proposal.

Sponsored access represents about half of U.S. equities trading, with unfiltered access accounting for 38 percent, Aite Group LLC, a financial services research firm in Boston, said in a December report. The SEC has been under pressure from Senator Ted Kaufman of Delaware and others to address concerns that so- called high-frequency firms could disrupt the market with trading that isn’t properly monitored through tactics such as unfiltered market access.

Jeopardizing a Firm

Accidental orders and those that don’t comply with regulations could enter the market, jeopardizing the firm getting sponsored access or its executing and clearing brokers, according to Schapiro. Sponsored access refers to arrangements where a broker gives customers its identification number so they can trade on exchanges or other venues.

In addition to the potential for erroneous trades, naked sponsored access may allow deliberate fraud and illegal trading such as improper short selling to go unmonitored, according to the SEC.

“Such ‘unfiltered’ arrangements occur mainly to give a customer -- often a high-frequency trader -- a fraction-of-a- second advantage in the high-speed transactional world that exists today,” Schapiro said.

The SEC’s proposal would require brokers to establish pre- trade risk controls and supervisory procedures for customers that now get unfiltered access. These include safeguards to reduce the chances of erroneous orders due to computer malfunctions or human error, orders that potentially breach a firm’s credit or capital limit, and those that fail to comply with regulatory requirements.

Risk Controls

Robert W. Cook, the new director of the SEC’s division of trading and markets, said the SEC has “increased concerns about the quality of broker-dealer risk controls in all market access arrangements,” particularly when there is “little or no substantive intermediation by the broker-dealer providing that access.” Risk checks “must be under the direct and exclusive control of the broker-dealer” and cannot be delegated to the firm getting sponsored access to exchanges, he said.

Many of the biggest brokers don’t allow unfiltered access and have been critical of the practice. New York-based Goldman Sachs Group Inc. and Morgan Stanley permit customers to use sponsored access as long as their orders are checked for risk.

The Aite report said the industry average for typical pre- trade risk checks is about 125 microseconds. A microsecond is a millionth of a second.

Liquidity, Lower Fees

In addition to sponsored access, the SEC is seeking input from securities professionals on strategies used by so-called high-frequency traders after lawmakers including Kaufman, a Democrat, questioned whether the practice is benefiting Wall Street at the expense of individual investors. Proponents of the technique say it has lowered fees, boosted liquidity and increased volume.

The SEC is reviewing “what effect this massive transformation in which high-frequency trading dominates volume may be having on individual and fundamentally driven investors,” and whether it disadvantages them,” said Justin Schack, director of market structure analysis at Rosenblatt Securities Inc. in New York.

The SEC asked for guidance on whether to impose new rules on high-frequency trades, whether “highly automated, high- speed” trades hurt investors and what metrics regulators should use to determine the effects of new trading strategies on long- term investors, the agency said in a statement today.

Computer Access

The SEC also asked about co-location, where traders and securities firms place servers close to the main computers of exchanges in data centers to shave time off their orders. The agency wants to know whether co-location gives traders unfair advantages and whether firms using this service should face regulations.

SEC commissioners voted 5-0 today to publish a so-called concept release that will solicit feedback from traders, brokerages and stock exchanges. The SEC will seek comments for 90 days before deciding whether to propose any regulations.

"Regulators are set to stir old controversies this week when they meet to release a paper on high-frequency trading and the broader U.S. equity markets, expected to review myriad changes over the last decade.

The U.S. Securities and Exchange Commission will vote Wednesday on whether to issue the concept release on everything from placing traders’ computers next to exchange computers, known as co-location, to the value of anonymous venues known as dark pools.

The SEC, under pressure by some lawmakers and others to do the comprehensive review despite no serious problems in stock markets, said this month the paper would look at “the performance of equity market structure in recent years,” and solicit public comment.

Industry sources said they expect the SEC to raise thorny questions such as the possibility that high-frequency traders’ lightning-quick algorithms prey on less-sophisticated investors, and whether to saddle them with new obligations.

The regulator is also expected to ask whether changes are needed to the sweeping Regulation National Market System (Reg NMS), which in 2005 forced exchanges to route orders to the venue with the best price — a move that connected U.S. markets like never before, and set them apart from other regions.

“I think we’ll have to sort through all of the existing regulations again in 2010,” said Sang Lee, managing partner focused on market structure at Boston consultancy Aite Group.

Staffers will present the concept release to SEC commissioners at the 10 a.m. EST (1500 GMT) meeting. The paper would be published shortly or within days after the vote, an SEC spokesman said.

A concept release can be the first step in the SEC’s rulemaking process. However some papers have been abandoned with no action.

Traders, analysts, and exchanges said they expected no significant market structure changes, if any, until 2011. Few would comment on record due to the sensitivity over the paper.


High-frequency trading muscled onto regulators’ already cluttered radar last year during concerns about manipulation and market stability, and with news that the trading practice was involved in an estimated 60 percent of U.S. equity volumes.

An official at one large fund management company, who requested anonymity, said he thinks some high-frequency algorithms “might be less genuine than markets would hope for.”

Senator Ted Kaufman, a Democrat from Delaware, has been a particularly vocal critic of lightning fast trading strategies, concerned it is creating a two-tier system of investors and could lead to market chaos.

The trading firms, many of which are proprietary, submit thousands of orders per second to make markets and profit from tiny price imbalances. They provide much liquidity, and argue there is little if any evidence of wrongdoing.

The SEC “will look at the various criticisms and allegations of high-frequency trading because they have to, regardless of how preposterous some of the claims are,” said a high-frequency trader who requested anonymity.

“We’re hoping they’re not pejorative in their approach and that they do not presuppose that we’re doing something wrong,” he said. “But I think they’ll do their best to be fair.”

Regulators will also consider on Wednesday proposing new risk management rules for the practice of “sponsored access,” where brokers give trading firms degrees of direct access to markets in exchange for a fee.


More broadly, the SEC could ask whether Reg NMS’s “trade through protection” is adequate, and whether a “trading at” ban is also necessary, said a source familiar with the SEC’s thinking.

Trade through protection bars exchanges and the dozens of alternative venues from executing orders at a worse price than exists on another venue. But they can keep that order in-house if there is an undisplayed, or “dark,” order willing to match it at the best national price — a move known as “trading at.”

A “trading at” ban could further heighten exchange competition, and put the time orders are received in sharper focus. It would also likely hurt dark pools, which already face a crackdown in separate SEC proposals.

It is unlikely the SEC is serious about adopting a “trading at prohibition,” the source said, noting Reg NMS was decided after about a five-year study of markets. “They’d propose it (as a question) because they’re under a lot of pressure on dark pools,” he said.

Chair Shapiro's speech to SIFMA

Market Structure

As many of you know, we are already moving forward on our market structure initiative. In recent weeks, we have proposed rules that would address the inequities of flash orders and dark pools of liquidity.

Both of these undermine the integrity of the market by providing valuable pricing information to select market participants — information that is not widely available to the public. This in turn creates a risk of private markets and two-tiered access to information.

But I believe there is much more to do to bring about greater market transparency and fairness.

As regulators, we at the SEC are mindful of the extraordinary technological advances and the benefits they have brought over the years. But, we are also mindful of the potential for participants to exploit these advances in ways that harm, rather than help, investors.

As a result, we have been engaged in a thoughtful, deliberate and comprehensive review of market structure.

In addition to the actions already taken, we will seek public comment on dark liquidity in all of its forms, including dark pool alternative trading systems, internationalization, dark order types on exchanges, and ECNs. And, we'll seek input on high frequency trading and the wide range of strategies that may fall within this vaguely defined category.

A related issue, on which we also expect to seek public comment, involves co-location — the process where exchanges allow some broker-dealers to place their servers in close proximity to the matching engine of the exchange. This could result in significant advantages, at least for certain traders for whom speed is of the essence. In the interim, we are making sure that exchanges offer these co-location services on terms that are fair and non-discriminatory and that are transparent to the public.

I also have asked the staff to review the rules governing ATSs to assess whether those rules are still appropriate for all the different types of ATSs that exist today — systems that may not have been foreseeable when our rules were adopted 10 years ago. But in addition, I have directed our staff to come up with actual market structure proposals as well.

One proposal will address the risk of sponsored access to exchanges. It will focus on arrangements that enable unfiltered access by non-regulated entities — in many cases, high frequency traders — to exchange systems. I liken it to giving your car keys to a friend who doesn't have a license and letting him drive unaccompanied.

The reason this raises concerns is that broker-dealers perform vital gatekeeper functions — functions that are essential to maintaining the integrity of the markets. We should not sacrifice the stability and fairness of the markets to give a trader a millisecond advantage.

I recognize some markets have been seeking to address this issue, but I also worry that competitive pressures could delay an effective solution — one that would apply across all markets to assure a level playing field for all investors.

A second proposal would shed greater light on the activities of high frequency traders.

Compared to a few years ago, the current volume of orders and trades, and the speed of order routing and trading, are almost unimaginable. The high frequency traders largely responsible for these developments now likely represent more than 50 percent of trading volume.

I believe we need a deeper understanding of the strategies and activities of high frequency traders and the potential impact on our markets and investors of so many transactions occurring so quickly. And we need to consider whether there are additional legislative authorities needed to address new types of market professionals whose activities may not be sufficiently regulated."

SEC adopts use of trader "self-reporting"

"If you have been wondering why Rentec, GETCO, Citadel and Highbridge are sweating these days, it is because the SEC is preparing to finally remove the rock they all crawl under as they execute millions of trades each and every second. As Traders Magazine reports, "the Securities and Exchange Commission, in an effort to get more information about high-frequency trading, plans to dust off an old statute that allows it to require large traders to "self-identify" themselves. As part of the plan, the SEC will propose a rule implementing a large trader reporting system for non-broker-dealers." So if you see any particularly abnormal market behavior these days, don't be surprised if it is simply due to Jimbo and Kenny doing all the can to pocket last any minute revenue before the hammer comes crashing down.

So why does the SEC care about identifying these huge, market moving non-broker institutions? Because, apparently the brilliant regulatory idiots do not have an idea of who trades what right now. Correct: the market regulator is unaware if GETCO moves a trillion shares of AIG stock all on its own. How the hell are these people policing the markets if they don't have access to something as simple as that?

This new effort is expected to give the SEC more visibility into the activities of some high-frequency trading firms. Currently, the SEC does not have this access to this information.

David Shillman, associate director of the SEC's Division of Trading and Markets, said the SEC can use its authority under Section 13(h) of the Securities Exchange Act to force large trading firms, including hedge funds and proprietary trading shops that are not broker-dealers, to file a form with the SEC and use an identification number when they trade. That would allow the SEC to gather information about their executions and help determine what impact, if any, they may be having on the marketplace.

"We need to get better baseline information about who the high-frequency traders are and what they're doing," Shillman said. He noted that high-frequency trading has grown significantly in recent years. "It has become such a dominant part of the market that now may be the time to revisit exercising our authority under Section 13(h)," he said.

"Among other things, the Commission has authority to require all large traders to self-identify and to use a large trader identifier when they trade," he said.

What is the basis of Section 13?

The authority to establish a large trader reporting system hails from the Market Reform Act of 1990, which Congress adopted in the wake of the 1987 market crash. The set of initiatives in that legislation was conceived to address the "causes of precipitous market declines," according to the SEC's 1991 annual report. Those initiatives also authorized the SEC to collect financial information on broker-dealer holding companies for risk assessment purposes, among other things.

The SEC in 1991 proposed Rule 13h-1, which sought to establish a large trader reporting system. The proposed rule required large traders to file a form with the SEC and receive a large trader identification number. That number would have to be used by all broker-dealers effecting trades for that firm.

The large trader reporting system never got off the ground. Foreign banks resisted the rule because of confidentiality laws in their home countries [no worries there anymore, eh UBS?], and in 2000 the SEC instead proposed Rule 17a-25. That rule requires brokers to electronically send the SEC information about "customer and proprietary securities trading," when the Commission requests that information. The rule, adopted in 2001, enhanced the Electronic Blue Sheet system, which enables the SEC to get transaction and related information from brokers. The EBS system got its name from the blue paper that the SEC's information requests had previously been printed on.

As for why regulation on a by exchange basis is idiotic, and why Rentec will always be able to nickel and dime the populace absent a global overhaul in regulation that tracks the order flow by execution not by venue:

"Right now, we are looking through a translucent veil, and only seeing the registered firms, and that gives us an incomplete--if not inaccurate--picture of the markets," he said. FINRA is the primary regulator of broker-dealers and is making a pitch to conduct consolidated market surveillance across market centers. Ketchum noted that market surveillance is made more difficult by the ability of firms to move order flow from one market center to another "on a second-by-second basis."

But what is making the East Setauket boys most nervous, is that practically overnight their entire strategic advantage (recall numerous filing under seal in any litigation involving Renaissance) will be taken away:

That additional legislative authority, Shillman said, could provide the SEC "with more direct oversight of unregulated high-frequency traders." That oversight could allow the Commission to more effectively probe the trading strategies of firms and propose rules to address activities that are considered problematic, he said.

We appreciate the SEC being ahead of the curve on this one, just as it has been so prescient on all other matters. Should this initiative become effective we would be even willing to acknowledge, in a manner taking after the Obama administration, that the SEC has prevented or forestalled 600,000 market crashes. Unfortunately any regulator is only as good as its most recent horrendous judgment (and the SEC has many of those)."

SEC Concept Release expected in December

"U.S. regulators looking into high-frequency trading have asked the industry if institutions are flocking to so-called dark pools and increasing market volatility, sources familiar with the SEC's line of questioning said on Monday.

The Securities and Exchange Commission is not expected to release a discussion paper on high-frequency trading and other market developments being scrutinized by some lawmakers at least until December, the sources said.

High-frequency trading now accounts for an estimated 50 percent to 70 percent of all U.S. equity trading and is growing fast in other regions and asset classes. In it, banks, hedge funds, and independent shops use ultra-quick algorithms to make markets and capitalize on tiny spreads and market imbalances.

Some politicians and investors have raised concerns the practice, which effectively replaced traditional market-makers over the last decade, creates a two-tiered market favoring the most sophisticated players.

On Wednesday, a congressional panel will examine high- frequency trading and other recent market developments such as so-called dark pools, or anonymous trading venues where quotes are not displayed publicly

The SEC has said it wants to issue the discussion paper, in which it will ask questions about whether the rules have kept up with the current market structure to better understand the impact of high-frequency trading, which remained one of the most profitable lines of business throughout the financial crisis.

The discussion paper or so-called concept release can be a precursor to rule making and will be open for public comment.

One source said SEC staff have spoken first-hand to some high-frequency shops about volatility and how buyside firms are reacting to faster markets, adding that the staff is still in gathering information.

A second source said the regulator was also asking whether the shift to dark pools was increasing volatility in the public markets.

The SEC has already proposed ways to shed light on the dark pools and has proposed banning so-called flash orders, which give advance knowledge of stock orders to certain traders."

SEC proposes ban on flashed stock orders

The U.S. Securities and Exchange Commission proposed banning flash orders after lawmakers said the practice may give hedge funds an advantage over other investors.

SEC commissioners unanimously voted today to seek public comment on a rule barring exchanges and trading platforms from giving clients access to information about stock orders a fraction of a second before the market.

“Investors that have access only to information displayed as public quotes may be harmed if market participants are able to flash orders and avoid the need to make the orders publicly available,” Chairman Mary Schapiro said.

Democratic Senators Charles Schumer and Ted Kaufman urged the commission to halt the practice, arguing frequent traders use technology to profit from access to information not available to retail investors. Direct Edge Holdings LLC has relied on flash orders to take market share from NYSE Euronext.

Nasdaq OMX Group Inc. and Bats Global Markets voluntarily dropped flash orders last month after the practice drew scrutiny from Congress and the SEC.

The SEC’s proposed ban requires a second vote at a later public meeting to become binding.

SEC encouraged to ban flash trades

"The U.S. Securities and Exchange Commission will seek to ban flash trades that give some brokerages an advance look at orders, Senator Charles Schumer said, citing a conversation with SEC Chairman Mary Schapiro.

Schapiro assured Schumer in a phone call yesterday that the agency plans to ban the practice, according to a statement from his office. In a separate release, Schapiro said she has asked her staff to draft rules that “quickly eliminate the inequity” that flash orders cause.

“It’s preferencing one group over another, and that’s not the way markets should work,” said Michael Panzner, author of “The New Laws of the Stock Market Jungle” who once traded for George Soros’s hedge fund. “It certainly on its face seems unfair and up until now was against the spirit, now perhaps against the actual rules, of fair play.”

A ban would reverse decisions since at least 2004, when the SEC first approved the systems at the Boston Options Exchange. Nasdaq OMX Group Inc., Bats Global Markets, Direct Edge Holdings LLC and the CBOE Stock Exchange give information to their clients about orders for a fraction of a second before the trades are routed to rival platforms. The technique is meant to give investors another opportunity to complete a transaction.

Schumer told the SEC in a July 24 letter to halt flash orders, saying he would propose legislation barring them if the agency didn’t act. NYSE Euronext, the world’s largest owner of stock exchanges, as well as brokerages Morgan Stanley and Getco LLC have said the practice may result in investors getting worse prices."

"The lightning fast world of high-frequency equity trading is being scrutinised by the US SEC, amid concerns that this computer-dominated scene is placing less tech-savvy investors at a disadvantage. Volumes of trading generated by computers placing super-fast orders has rocketed in recent years. HFT accounts for as much as 73% of US daily equity volume, up from 30% in 2005, according to estimates by Tabb, a consultancy."

"The US SEC on Monday said it was examining “flash” orders – trades made at lightning speeds on electronic systems – after calls by US Democrat senator Charles Schumer to ban the practice. Officials are conducting a review that includes examining flash orders by exchanges and automatic trading systems that disseminate information to select market participants, ‘’potentially disadvantaging investors,’’ said a SEC spokesman."

Chicago Fed questions systemic risk of HFT

The key recurring topic on Zero Hedge over the past year has been our ongoing warning over the threats presented by high frequency trading on proper market functioning. A few isolated voices, most notably Delaware senator Kaufman have enjoined this effort and have demanded that the SEC propose a market review in which the role of HFT is closely scrutinized, yet we are fairly confident that absent another major market crash precipitated precisely by the factors that we have been warning against, the SEC will end up doing absolutely nothing, until it is too late. Yet we are gratified that today, none other than the Chicago Federal Reserve has taken up the cause of admonishing about the broad and systematic danger that HFT presents to market topology. In a paper titled "Controlling risk in a lightning-speed trading environment" in which the Chicago Fed says that regulators should examine the risks of HFT which has the potential to amplify systemic risk and errors.

The paper notes:

A handful of high-frequency trading firms accounted for an estimated 70 percent of overall trading volume on U.S. equities markets in 2009. One firm with such a computerized system traded over 2 billion shares in a single day in October 2008, amounting to over 10 percent of U.S. equities trading volume for the day. What are the advantages and disadvantages of this technology-dependent trading environment, and how are its risks controlled?... The high-frequency trading environment has the potential to generate errors and losses at a speed and magnitude far greater than that in a floor or screen-based trading environment. The paper's author, Carol Clark, asks whether those using HFT are ready to withstand the potential losses due to the lack of any regulatory framework from a risk-to-capital standpoint.

Her conclusion:

The high-frequency trading environment has the potential to generate errors and losses at a speed and magnitude far greater than that in a floor or screen-based trading environment. In addition, the types of risk-management tools employed by broker–dealers and FCMs, their customers, nonclearing members, exchanges, and clearinghouses vary; and their robustness for withstanding losses from high-frequency algorithmic trading is uncertain. Because these losses have the capability of impacting the financial conditions of the broker–dealers and FCMs and possibly the clearinghouses, determining and applying the appropriate balance of financial and operational controls is crucial. Moreover, issues related to risk management of these technology-dependent trading systems are numerous and complex and cannot be addressed in isolation within domestic financial markets. For example, placing limits on high-frequency algorithmic trading or restricting unfiltered sponsored access and co-location within one jurisdiction might only drive trading firms to another jurisdiction where controls are less stringent. We are confident that as ever more "relevant" market participants realize the persistent threat posed by HFT, the risk parameters that HFT participants, many of which are merely a group of math Ph.D.'s with a collocated station and a few algorithms, will be substantially reinforced. This will inevitably mean the elimination of a vast number of marginal players who will be unable to ensure their capital adequacy in proposed draconian-downside scenarios (which ironically would merely be reinforced by the very algorithms that have ridden the market ever higher since the March bear market squeeze began).

==UK Treasury examines HFT threat to economy

The UK Treasury is sponsoring a probe into high-frequency trading amid fears that computer-generated problems could hit financial stability, affecting the whole economy, according to the Financial Times.

Citing an e-mail from within the Treasury, the FT says Lucas Pedace, in the government Office for Science, part of the Department for Business, Innovation and Skills, will lead a group studying the issue.

The e-mail says that the 6 May US "flash crash" - when the Dow Jones industrial average plummeted in minutes - shows the "vulnerability" of high-frequency trading, claiming the tactic was a contributory factor to a decline in confidence.

"The possibility remains of a computer-generated trading failure occurring in the UK and having a significant economic impact," says the e-mail.

In the US, the Securities and Exchange Commission is expected to publish its report into the flash crash soon, with high-frequency trading and technology expected to bear some of the blame. In Europe, the phenomenon is also being investigated as part of an overhaul of the Markets in Financial Instruments Directive (MiFID).

"Companies could become the "playthings" of speculators because of super-fast automatic share trading, Treasury minister Lord Myners has warned.

The peer, a former fund manager, told the BBC this was one of the main dangers of such a system. High-frequency trading (HFT) is automated dealing where shares change hands, frequently in microseconds.

Lord Myners said the process risked destroying the relationship between an investor and a company.

It is estimated that HFT has risen sharply in the USA and now accounts for up to 70% of all share trades and is rising rapidly in the UK and Europe.

But Lord Myners told the BBC's File on 4 he already had doubts about this development.

"I have been increasingly troubled that we seem to find ourselves in a situation in which shares are to be bought and sold rather than being part of an ownership relationship between investor and a company," he said.

"The danger is that nobody really seems to think of themselves as owners."...

..."The danger is that companies become the playthings of speculators."

Overview of HFT

"...You see, flash trading is a unique equities-focused practice in which, for a fee, clients are granted previews of order flows ahead of other market participants.

High frequency trading is a generic term for any trading strategy that uses computers and algorithms to blast multiple buy/sell orders, or signals in order to expose other participants’ hidden limits, ice-berged but not-yet-executed orders, or which uses server proximity to gain a latency advantage over others.

Algorithmic trading, meanwhile, is a term that encompasses just about everything. In simple terms, anything that uses computer programming to spot and trade arbitrage opportunities cross asset or cross contract, advise or trade on technical buy/sell points, and automate the trading process if certain signals are detected. In effect algorithms that facilitate statistical arbitrage most of the time. The best known algorithm of all is probably the automated execution of stop losses."

"It is the hot new thing on Wall Street, a way for a handful of traders to master the stock market, peek at investors’ orders and, critics say, even subtly manipulate share prices.

It is called high-frequency trading — and it is suddenly one of the most talked-about and mysterious forces in the markets.

Powerful computers, some housed right next to the machines that drive marketplaces like the New York Stock Exchange, enable high-frequency traders to transmit millions of orders at lightning speed and, their detractors contend, reap billions at everyone else’s expense.

These systems are so fast they can outsmart or outrun other investors, humans and computers alike. And after growing in the shadows for years, they are generating lots of talk.

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.”

For most of Wall Street’s history, stock trading was fairly straightforward: buyers and sellers gathered on exchange floors and dickered until they struck a deal. Then, in 1998, the Securities and Exchange Commission authorized electronic exchanges to compete with marketplaces like the New York Stock Exchange. The intent was to open markets to anyone with a desktop computer and a fresh idea.

But as new marketplaces have emerged, PCs have been unable to compete with Wall Street’s computers. Powerful algorithms — “algos,” in industry parlance — execute millions of orders a second and scan dozens of public and private marketplaces simultaneously. They can spot trends before other investors can blink, changing orders and strategies within milliseconds.

High-frequency traders often confound other investors by issuing and then canceling orders almost simultaneously. Loopholes in market rules give high-speed investors an early glance at how others are trading. And their computers can essentially bully slower investors into giving up profits — and then disappear before anyone even knows they were there.

High-frequency traders also benefit from competition among the various exchanges, which pay small fees that are often collected by the biggest and most active traders — typically a quarter of a cent per share to whoever arrives first. Those small payments, spread over millions of shares, help high-speed investors profit simply by trading enormous numbers of shares, even if they buy or sell at a modest loss.

“It’s become a technological arms race, and what separates winners and losers is how fast they can move,” said Joseph M. Mecane of NYSE Euronext, which operates the New York Stock Exchange. “Markets need liquidity, and high-frequency traders provide opportunities for other investors to buy and sell.”

The rise of high-frequency trading helps explain why activity on the nation’s stock exchanges has exploded. Average daily volume has soared by 164 percent since 2005, according to data from NYSE. Although precise figures are elusive, stock exchanges say that a handful of high-frequency traders now account for a more than half of all trades. To understand this high-speed world, consider what happened when slow-moving traders went up against high-frequency robots earlier this month, and ended up handing spoils to lightning-fast computers.

It was July 15, and Intel, the computer chip giant, had reporting robust earnings the night before. Some investors, smelling opportunity, set out to buy shares in the semiconductor company Broadcom. (Their activities were described by an investor at a major Wall Street firm who spoke on the condition of anonymity to protect his job.) The slower traders faced a quandary: If they sought to buy a large number of shares at once, they would tip their hand and risk driving up Broadcom’s price. So, as is often the case on Wall Street, they divided their orders into dozens of small batches, hoping to cover their tracks. One second after the market opened, shares of Broadcom started changing hands at $26.20.

The slower traders began issuing buy orders. But rather than being shown to all potential sellers at the same time, some of those orders were most likely routed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — in what are known as flash orders. While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee.

In less than half a second, high-frequency traders gained a valuable insight: the hunger for Broadcom was growing. Their computers began buying up Broadcom shares and then reselling them to the slower investors at higher prices. The overall price of Broadcom began to rise.

Soon, thousands of orders began flooding the markets as high-frequency software went into high gear. Automatic programs began issuing and canceling tiny orders within milliseconds to determine how much the slower traders were willing to pay. The high-frequency computers quickly determined that some investors’ upper limit was $26.40. The price shot to $26.39, and high-frequency programs began offering to sell hundreds of thousands of shares.

The result is that the slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders.

Multiply such trades across thousands of stocks a day, and the profits are substantial. High-frequency traders generated about $21 billion in profits last year, the Tabb Group, a research firm, estimates.

“You want to encourage innovation, and you want to reward companies that have invested in technology and ideas that make the markets more efficient,” said Andrew M. Brooks, head of United States equity trading at T. Rowe Price, a mutual fund and investment company that often competes with and uses high-frequency techniques. “But we’re moving toward a two-tiered marketplace of the high-frequency arbitrage guys, and everyone else. People want to know they have a legitimate shot at getting a fair deal. Otherwise, the markets lose their integrity.”

Stay one millisecond ahead

Source: What’s the frequency, SEC? Reuters, July 21, 2009

"Computer-driven trading, where complex buy and sell orders are completed in fractions of a second, now account for 73 percent of all daily stock trades in the United States, according to the Tabb Group, a financial services research firm. Tabb also estimates that the 300 securities firms and hedge funds that specialize in rapid-fire algorithmic trading raked in some $21 billion in profits last year.

Admittedly, the $21 billion figure is really just a best-guess estimate. The vast majority of hedge funds and trading firms that engage in high frequency trading — Citadel Investment Group, D.E. Shaw, Global Electronic Trading Company, Renaissance Technologies and Wolverine Trading — are private and don’t reveal much, if anything, about their operations. Even a public company like Goldman, an acknowledged leader in high frequency trading, is silent on the profits it generates.

Still, there’s little doubt there’s a lot of money to be made from automated trading that relies on complex mathematical formulas to predict momentary price moves in stocks and commodities. The name of the game in high frequency trading is literally trying to stay one millisecond ahead of the competition thousands of times a day. High frequency traders also earn lucrative “rebates” from stock exchanges by serving as de facto market makers for fast-moving stocks

The big fear is that with high frequency trading dominating daily trading activity, it could spark another 1987-style market crash. The doomsayers say that could occur if all these automated trading programs — which operate with almost no adult supervision — begin reacting to the same downward price trends in a stock or commodity. Or high frequency trading firms could worsen a sell-off by refusing to execute trades to protect their own capital, a move that would make it difficult for other investors to quickly exit a falling stock.

Some say there’s already evidence high frequency trading may be playing havoc with the markets. James Angel, a professor at Georgetown University’s McDonough School of Business, says the big end-of-the-day price swings in the major stock indexes that were quite common last fall were probably exacerbated by high frequency trading.

High frequency trading may have added to a still unexplained 69 percent plunge in shares of Dendreon on April 28. The Seattle-based drug company’s stock fell precipitously in less then two minutes before officials at the Nasdaq Stock Market were forced to halt trading.

The sell-off began on a rumor that Dendreon was about to announce some bad news. In fact, the opposite occurred, as the company released some positive test results for its prostate cancer treatment drug Provenge. Once trading resumed, the share price quickly recovered.

Now wild price swings in shares of biotech stocks aren’t unusual and such stocks are favorite targets for short sellers. But Angel suspects that high frequency trading programs may have exacerbated the plunge when the algorithms these trading firms use all glommed onto the same trend. “The downside is that when some algo misfires, our market is shockingly not protected from it.”

Angel’s remedy for reining in high frequency trading is for regulators and exchanges to institute a price circuit breaker for every stock — similar to the broad-based circuit breakers that were adopted by the major stock market indexes after the 1987 crash. He points out that many foreign exchanges with heavy electronic trading currently employ some form of automatic price circuit breaker for individual stocks.

“Right now, we rely on humans at the exchanges to pull the alarm, but in the nanosecond world that is too slow,” Angel says.

At first blush, Angel’s suggestion makes a lot of sense. It’s certainly better than anything the regulators are doing to control the risks posed by high frequency trading. (Editing by Martin Langfield)"

‘We’re Just Waiting For A Disaster”

Market chatter suggests computer generated trading sent Wall Street spiraling out of control on Thursday. And it’s got Mark Fisher of MBF worried, very worried.

Mark Fisher, founder and managing member of MBF Asset Management, rarely comes on TV but he felt Thursday's events were so important he agreed to an interview.

"I came on TV because as someone who's been doing this for over 35 years I think this is a warning," he says.

"I think what we saw on (Thursday) is just the tip of the iceberg," Fisher says. "There is no way this isn't going to happen again and again and again unless we can slow the process down.”

Fisher is hoping that in the wake of Thursday's plunge, lawmakers and the CFTC put together a group of traders and academics and create rules and regulations to slow everything down, especially in times of high distress.

"We're trading in micro-seconds," he says. "In the time it takes to tap your desk, a good trading shop can put out 10,000 orders. That just can't be allowed to continue."

Fisher has a lot of interesting insights. Check out our entire interview. Watch the video now!

HFT concentrated in few stocks

"There are so many distortions in the markets today that traditional technical indicators are no longer as reliable as in the past. Trading volume in the markets used to be a most reliable indicator. But today, about 50-70% of daily trading volume is from the "high frequency" trading computers. Imagine! If it weren't for these, the stock market might have to shorten hours for lack of interest. But trading volume in the dollar term is at a record high. What's going on? Here is a great chart from our colleague, Alan Neuman's Crosscurrents (www.cross-currents.net):

It shows that although the total worth of listed stocks is now lower than in 1998, the dollar value of trading is about 3 times greater. That's the "high frequency" trading operations. They are in a trade only for minutes or a few hours. That's keeping the exchanges alive. They need that business.

Additionally, big volume has come from just four stocks: Fannie Mae, Freddie Mac, AIG, and Citigroup. On some days, these four stocks accounted for 40% of total volume. The first two firms are considered to be totally worthless by some analysts. To us that confirm that this rally has nothing to do with "investing," but more with computerized speculation.

Timestamping trades in nanoseconds

Kx Systems, a provider of high-speed database and timeseries analysis, has announced today the release of version 2.6 of kdb+. The most significant feature of this release is the addition of nanosecond timestamps as built-in data types. (A nanosecond is a billionth of a second.)

The constant increase in data volumes and the resulting need for greater accuracy and granularity were the drivers behind Kx's decision to make the nanosecond timestamp available to its client base. There is a trend among exchanges to provide greater precision, but while some data providers support microsecond accuracy (i.e. six decimal places), end users can't always take advantage of this. In kdb+, nanosecond timestamps (9 decimal places) are built-in data types making the unique identification of the most recent events, such as trades, straightforward and enabling faster processing and simpler and more elegant code.

Chi-X has signed an agreement with IBM to install its high speed messaging technology. This move is part of a larger race among liquidity providers to increase the speed of their services. Chi-X, the multilateral trading facility, plans to install the IBM WebSphere MQ Low Latency Messaging platform in order to provide even faster high speed messaging to its dealers.

The deal was signed with Chi-X Global Technology, the technology services unit of Chi-X Global. The IBM platform will be embedded into the MTF's exchange and market centre trading technology platform and will run on Linux.

IBM's WebSphere MQ Low Latency Messaging is a high speed messaging transport for high volume, low-latency trading.

This is not the first exchange to adopt IBM's low latency technology. Last month, the Deutsche Börse selected messaging technology from Big Blue as part of a project to bring its Eurex, ISE and Xetra exchanges onto a common IT infrastructure.

Just this week, the London Stock Exchange confirmed it will buy Sri Lanka's MilleniumIT for around £18 million and use the vendor's technology to replace its TradElect platform.

Industry observers comment that the influx of new technology to support faster messages at MTFs and exchanges is part of an overall race to provide even greater low latency services to the competitive European dealer market.

Predtory algorithmic HFT preying on less liquid stocks

"While we would agree that the large cap space is in fact a playground for at least one style of HFT (rebate-driven), and that liquidity is added by HFT in the top 100 large cap stocks, and spreads are tightened as a result in the top 100 large cap stocks, we agree with the NYSE study that shows that outside that group of stocks, volatility has increased, and spreads have widened.

We do not believe that this is due to a LACK of HFT in the space, but rather it is due to predatory algorithmic HFT preying on less liquid stocks. There is plenty of HFT in small caps! We battle them every day for our clients. And buyside traders comment to me daily that each day it is like a cage match out there. As soon as they start buying a stock, bid, or take on offer, wheels are set in motion where, the buyside footprint is detected, predatory HFT accumulates positions in front of that presence, and sells it back to the buyside higher. The presence of HFT in small and midcap stocks is actually much more obvious than in large cap stocks, by many accounts."

How HFQ algo traders push out market makers

Rambus (RMBS) fell 30% today in a matter of five minutes. It immediately bounced back. The cause for this move was speculated as a trader with a “fat finger”. A trader simply messed up and sold too much stock accidentally, causing a swift and violent sell-off.

The trades were later deemed erroneous and busted by the exchange.

But what if the real cause wasn’t just a trader with a “fat finger”, accidentally selling too much stock? What if it was something more serious? I believe it is. I believe the real cause for this move is a major concern for our markets. The real cause may have been high frequency market making gone bad. Let me explain.

Market making is the practice of quoting both bids and offers on the same security, in hopes of capturing the spread. Market making has existed in our markets since the beginning. Traditionally it was done by floor brokers, floor traders and specialists. With the rise of the internet in the last 1990s, new players emerged in the market making practice. Proprietary traders, and E-traders began to play the game. This led to increased competition and tighter spreads. But in the past five years a new player has emerged, and this player has become dominant, knocking many of the competitors out of the game. This new player is the high frequency algorithmic trader, and it’s not a person, it’s a computer. 70% of our daily volume is now done by algorithmic computer systems. Much of this volume is market making. Why has the HFT computer become such a dominant player? It has to do with their edge.

High frequency algorithmic systems have been programmed to step inside the NBBO (National Best Bid and Offer), and be the best bid and best offer. This puts the computer system at the front of the line to be first for execution, and gives the computer the best chance to capture the spread. Unfortunately, this practice is dominated by a few large firms, and they have driven traditional market makers out of the market. If a traditional market maker places a bid, the computer automatically steps in front. In some cases, it steps in front by as little as 1/100th of a penny (a practice called sub-pennying, which is discussed on my website http://www.defendtrading.com).

These programs are very predatory and step in front of the NBBO on a constant basis. This has driven liquidity providers out of the market. Our proprietary trading firm, Bright Trading LLC, in the early 2000s, used to account for 2% of the volume on the NYSE. Now we account for just a fraction of that. Our 400 traders used to provide a substantial amount of liquidity to the market. But due to predatory HFT market making practices, we now provide very little liquidity. We are now liquidity takers. The rational is simple, if we place a passive limit order (providing liquidity), the HFT algorithmic programs simply step in front of us. If we do get filled on a passive order, it is almost always because we are wrong. You are sub-pennied when you’re right, filled when you’re wrong. Hence, there is no point to us providing liquidity. Other proprietary trading firms, floor traders, and specialists are in the same boat. There is no way for them to compete with the algorithmic programs, so they don’t place passive orders.

Without traditional market makers, willing to step up and be the buyer of last resort, we risk having more incidents, like the Rambus incident.

Computerized algorithmic market making works in any type of oscillating market, as the computer can keep flipping out of it’s longs, and covering it’s shorts. It works in a trending market, as long as there is some type of choppy trade. The problem lies, when the computer system can’t flip out of the position. Most algorithmic systems are programmed with some type of risk parameter. If this risk parameter is breached, the computer will dump it’s position and cut it’s losses. This is what may have happened in RMBS today. An algorithmic system making markets on the long side, got too long, and was unable to wiggle out of the position because of the follow-through in selling pressure. Once it was down so much in the position (the risk parameter was breached), it dumped. This simply added fuel to the fire. That is why the sudden plunge to $16 happened. If you check the chart, you will not see this, because Nasdaq busted all trades under $22. But don’t kid yourself, these trades happened, and we should be very alarmed, because it will happen again, and it may happen to the entire stock market.

High frequency traders make markets on ALL stocks. As they continue to take dominance, and as more and more liquidity providers are driven out of the market by these HFT predatory algorithms, the likelihood of a crash continues to climb. All it takes is a little bad news, and a breach in the HFT’s algorithmic system’s risk parameters, and we’re in a lot of trouble.

This has happened before, it WILL happen again. Rambus was ONE stock today. Imagine if it was the entire market.

Dennis Dick, CFA, Bright Trading LLC

Share exchanges and HFT

NYSE defends high frequency trading

Source: High-Frequency Trading Helps Narrow Quoted Spreads NYSE blog, August 19, 2009

"The debate regarding high-frequency trading has become muddled by confusion over high-frequency trading itself, which generally provides liquidity to the market, and flash-type orders. The NYSE agrees that flash order types are not in the market's best interests, but disagrees with those who try and lump that activity with beneficial high-frequency trading.

One predicted beneficial effect of High Frequency Trading (HFT), should be lower quoted spreads (the difference between the bid price and the offer price on a stock), in stocks where high-frequency activity is common. High-frequency traders tend to be most prevalent in the highest-volume stocks, because such stocks afford more opportunities to execute high-frequency strategies, with lower risk."

Getco to become NYSE designated market maker

Getco LLC, the high-frequency trading specialist founded a decade ago, agreed to become a so- called designated market maker at the New York Stock Exchange, a move that will add liquidity as the biggest U.S. equity venue seeks to halt share losses.

Getco, based in Chicago, purchased 350 assignments from Barclays Plc, according to a statement today from NYSE Euronext, owner of the New York Stock Exchange, for an undisclosed price. The designation means Getco will be obligated to buy and sell shares at the national best bid and offer price, as well as participate in the opening and closing trading sessions.

The move formalizes Getco’s role as a market maker with the NYSE after serving as one on electronic platforms through its computer-driven strategies that produce hundreds of buy and sell orders every second. So-called high-frequency traders make up more than 60 percent of U.S. stock volume, according to New York-based research firm Tabb Group LLC.

“There’s been a five- to seven-year run of high-frequency guys getting more and more important, and the exchanges needed to cater to these folks,” said Jamie Selway, founder and managing director of White Cap Trading LLC, a New York-based trading firm. “The NYSE has been late to the party, but they finally got there. For the NYSE, the ability to attract someone like Getco to commit as a DMM is a big deal. Getco is among the best at this.”

Getco also will become a designated market maker in Nasdaq- listed securities on the NYSE Amex, Larry Leibowitz, chief operating officer at NYSE, said in the statement.

Barclays bought LaBranche & Co.’s designated market-making business for $25 million last month, cutting the number of firms providing the service on the floor of the NYSE to four. Floor trading at the NYSE has been slowing as investors shift to electronic systems for placing orders for stock, away from using specialists who work at the exchange in Manhattan. NYSE’s share of U.S. equity trading has fallen to about 28 percent at the end of 2009 from about 33 percent at the start of the year.

Exchanges court big banks as shareholders

Peace is breaking out between exchanges and their main customers, the world’s biggest banks.

This week NYSE Euronext unveiled plans to sell a “significant” equity stake in NYSE Amex Options, one of two options markets it runs, to Bank of America Merrill Lynch, Barclays Capital, Citadel Securities, Citigroup, Goldman Sachs, TD Ameritrade and UBS.

The deal highlighted a trend that is quietly spreading through the exchange business: exchanges are courting their biggest customers – many of which have had fractious relations with the exchanges – in launching new initiatives.

They believe they must bring in their biggest customers as partners to share revenue and ideas, if business initiatives are to succeed.

For many banks, and some larger trading firms, the incentive to co-invest in these new ventures is the influence they gain in deciding market structures, and even fee levels.

In part, that explains why so-called “high-frequency trading firms” like Getco and Optiver are shareholders in Chi-X Europe, the pan-European share trading platform.

The development marks a sudden warming of relations between banks and exchanges after years of enmity, as the financial crisis has unearthed new threats that could hit both – such as heavier regulation and new taxes.

Banks used to be among the exchanges’ biggest owners in the days when exchanges were still mutually owned clubs.

That gave them some say in how exchanges were run. But when exchanges went public in the late 1990s, the banks’ influence waned.

In Britain relations reached a low point when nine of the biggest users of the London Stock Exchange, frustrated with the LSE’s high fees, struck out on their own by creating Turquoise, an alternative share trading platform that has helped force the LSE’s fees down by competing with it.

Now, however, there is a growing sense that “re-mutualisation” could help ensure that the business continues to innovate.

Walter Lukken, global vice-president of market structure at NYSE Euronext and until recently acting chairman of the Commodity Futures Trading Commission, the US futures watchdog, says: “I think there’s going to be a degree of re-mutualisation. One way to get people to come to your market is to give them skin in the game.”

Garry Jones, the group’s global head of derivatives, says “part-mutualisation” is also helpful “because we are doing more projects outside our core markets.”

Many argue the new approach has been pioneered by Jeff Sprecher, chief executive of the IntercontinentalExchange, the futures exchange and over-the-counter derivatives platform.

Last year, ICE set up the first clearing house for OTC credit default swaps in a revenue-sharing arrangement with many of the biggest banks involved in CDS trading. Mr Sprecher is a keen proponent of the “re-mutualisation” approach to running exchanges.

ICE’s European rival, Eurex Clearing, is following suit, offering equity in its OTC derivatives clearer, launched last month. Marcus Zickwolff, head of trading and clearing system design, says: “Those OTC markets can only successfully be cleared together with the major players which have created these markets.”

Xavier Rolet, the new chief executive of the LSE, has spent much of his first four months in the job trying to rebuild relations with the exchange’s 15 biggest bank customers.

The LSE is in talks with three to five banks about investing in Baikal, its planned dark pool. It is no coincidence that Mr Rolet is a former Lehman Brothers and Goldman Sachs executive involved in handling relations with exchanges.

However, the development does not mean exchanges are finding it easy to find partners for every initiative.

NYSE Euronext’s futures exchange, NYSE Liffe, has been seeking equity investors in its US operation from the ranks of the largest futures broking banks for a year, with nothing signed yet.

There are also signs that animosity between some exchanges and the banks is alive and well in some quarters.

ELX, a US futures exchange backed by a group of banks and Getco, is attempting to compete with the CME in US treasury futures contracts. The CME has a dominant position in US futures and has dismissed the threat.

But it has been struggling to get its own CDS clearing house off the ground, largely because it decided early on to adopt the opposite approach to ICE, spending insufficient time trying to bring the dealer banks on board.

High frequency traders are not market makers

Source: Seth Merrin Examines the Pros and Cons of High Frequency Trading Advanced Trading, August 19, 2009

"This is an example where again— typical of Wall Street— there are a few that benefit at the expense of many," says Merrin in an exclusive video interview with Advanced Trading in his midtown Manhattan headquarters.

"Whenever there is a crack in the armor or someplace where you can make a lot of money, Wall Street figures it out very quickly and that's where they go," said Merrin.

While flash orders are used to give a sneak peak at order flow to participants on a private network so they can match a trade before routing out to a public market, Merrin says this is no different than an institution giving an order to a broker and finding out that the broker relayed the order to different hedge funds. "What would you do with that broker?" asked Merrin.

"The problem is with three-or-four of the major ECNs and exchanges offering flash orders, there's no way for way to avoid it," says Merrin, referring to The Nasdaq Stock Market, BATS Exchange and Direct Edge. (Two of the three, Nasdaq and BATS Exchange, have volunteered to stop the practice by Sept. 1st). "The entire market became toxic for institutions," contended Merrin. Flash orders are not so bad for retail investors who have100 shares to buy or sell, but it's the institution with a million-share order to buy that is affected worse. "Billions of shares are being shown to these third parties and they don't know who they are and they certainly don't know what they are investing in," asserts Merrin...

...While industry analysts have said that high frequency trading is the next evolution of market making and adds liquidity to the equity markets and has narrowed spreads, Merrin said he would not put high frequency traders in the same category as market makers. He offered the example of Nasdaq having 4,000 listed securities, but ECNs are effective in the top 300 names. Still, the industry needs market makers in the bottom 3,700 names, he said. "High frequency trading is primarily in the largest most liquid names. What we need is capital provided in the least liquid names. They can't make money in the least liquid names. So are they providing the same services to the market as market makers?" asked Merrin. "The answer is no," he asserted.

Additionally, high frequency traders are not subject to the same regulatory structure and rules where they are required to make markets. "They go where the liquidity is and the opportunity is and they leave where the opportunity is not," said Merrin..."

Citadel's purchase of eTrade order flow halted

Source: Citadel’s E*Trade Bonanza Reuters, August 14, 2009

"Citadel Investment Group’s move to aggressively sell off its substantial stake in E*Trade Financial looks like hedge fund magnate Ken Griffin is throwing in the towel on his big gamble on the online broker.

But Citadel isn’t bailing on E*Trade. In fact, if Griffin gets his way, the Chicago hedge fund will have its fingers dug deeper into E*Trade, getting daily access to virtually all of the online broker’s stock and option trades.

With little fanfare, Citadel and E*Trade struck a tentative deal in June that would require the online broker to begin routing 97.5 percent of its customers’ Nasdaq stock and stock option trades to the hedge fund’s market-making operation.

Right now, E*Trade sends about 40 percent of its customer trades to Citadel’s market-maker division under a nearly two-year-old agreement that dates back to the hedge fund’s initial $2.5 billion investment in the broker.

This new exclusive six-year arrangement would mean even bigger bucks for Citadel’s already highly-profitable high-frequency trading business, given that E*Trade customers make more than 4 million trades a month.

Indeed, the deal is so potentially lucrative for Citadel that the hedge fund is willing to make an upfront $100 million cash payment to the financially-strapped online broker.

E*Trade’s regulator, the Office of Thrift Supervision, must approve the deal before it can take effect. And there are indications the OTS is about ready to give the deal the green light — possibly as soon as today.

(UPDATE: Scratch that. The OTS late Friday suspended consideration of the application, meaning Citadel’s plans are on hold.)

The OTS’ decision make sense because this was a case where the OTS should go slow and take its time, given all the recent controversy focused on high-frequency trading — a lightning-fast strategy in which computer-driven algorithmic programs buy and sell stocks, options and commodities in milliseconds."

Global regulatory approaches

IMF on HFT, flash trades and dark pools

Not all financial innovations increase efficiency. Here are three with questionable effects

THREE innovations in electronic trading of stocks and options have been in the headlines recently: high-frequency trading, flash trades, and dark pools. Technical improvements such as these are usually assumed to raise efficiency, but these innovations challenge such assumptions and may pose some public interest concerns because of their effect on stability.

Studying market microstructures illuminates the processes through which prices are determined. Markets often appear to be magic black boxes. Supply and demand go into the box and an invisible hand pulls out the price—much like a magician producing a rabbit from a hat. But important things happen inside those boxes.

In the case of electronic trading of securities and derivatives, the microstructure inside the box includes the mechanisms for submitting buy and sell orders (that is, bid and offer quotes) into a market, viewing of those quotes by market participants, and executing trades by matching orders to buy and sell. If this is done in an immediate and transparent manner that enables all market participants to see and trade at the same prices, then reality approaches the ideal of the efficient market hypothesis. When markets become segmented and informational advantages are built into market mechanisms, efficiency is impaired and fairness undermined.

This article explores these financial policy issues to explain how they impact pricing efficiency at the market microstructure level and to discuss how corrective regulation can improve efficiency.

High-frequency trading, flash trading, and dark pools all have their origin in two key marketplace innovations—electronic trading and the closely related alternative trading systems(ATS).

Electronic trading has quickly come to dominate traditional trading, both on exchanges and in over-the-counter markets. Computer systems automatically match buy and sell orders that were themselves submitted through computers.

Floor trading at stock and derivatives exchanges has been eliminated in all but the largest and most prominent markets, such as the New York Stock Exchange (NYSE), and even in those markets floor trading coexists with electronic trading. ATS are computer-automated order-matching systems that offer exchange-like trading opportunities at lower costs but are often subject to lower disclosure requirements and different trading rules..."

Read more here...

EU "Market Abuse Directive"

Technical Directive implementing the Market Abuse Directive

This Commission has also adopted a technical implementing Directive comprising a second set of measures, proposed by the Commission on the basis of the CESR's advice, to implement the Market Abuse Directive. The implementing Directive covers accepted market practices in the context of market manipulation, the definition of inside information in relation to derivatives on commodities, the drawing up of lists of insiders by issuers and persons acting on their behalf or for their account and the notification to the relevant authorities of suspicious transactions and of transactions undertaken by issuers' managers.

It will complement the first set of implementing measures, consisting of a Commission Regulation and two Commission Directives, already in force since December 2003 (see IP/04/16). The two sets of implementing measures as a whole will provide the detailed technical context ensuring that the Market Abuse Directive will achieve its aims of reinforcing market integrity, contributing to the harmonisation throughout Europe of the rules against market abuse and establishing transparency and equal treatment of market participants.

The implementing Directive will have to be written into national law by Member States by 12 October 2004, which is also the deadline for implementing the Market Abuse Directive itself.


In line with the new approach for regulating securities markets, the European Commission addressed on 18 March 2002 and 5 February 2003 two provisional mandates to the Committee of European Securities Regulators (CESR) for technical advice on possible implementing measures for the Prospectuses Directive. These provisional mandates by the Commission were formalised on 1 October 2003 after the adoption of the Directive (2003/71/EC).

Concerning the Market Abuse Directive, the European Commission addressed on 5 February 2003 a formal mandate to CESR for technical advice on a second set of possible implementing measures.

In order to guarantee the necessary transparency and maximise the effectiveness of the measures concerned, the CESR consulted market participants and the wider public before finalizing its advice. In line with the new procedure for deciding and applying securities legislation, agreed by the European Council in March 2001 and endorsed by the European Parliament in February 2002, the Commission made proposals taking into account that advice.

Now that the ESC has approved the proposals and the European Parliament has decided to agree to them, the Commission is, under the agreed procedure, in a position to formally adopt them.

The new approach for securities markets regulation comprises four-levels: namely broad framework principles included in legislation adopted by the European Parliament and Council (Level 1), measures implementing those Directives and adopted by the Commission after advice from the Committee of European Securities Regulators (CESR) and the agreement of the European Securities Committee, consisting of high-level representatives of the Member States (Level 2), co-operation among regulators (Level 3) and enforcement (Level 4).

FSA studies HFT

  • [ Britain studying high-frequency trading concerns] Reuters, February 2, 2010

Britain is studying the growth of high-frequency share trading to see if regulatory action is needed, a government minister said on Wednesday.

Financial Services Minister Paul Myners also said that the best way to curb excessive risks from proprietary trading at banks was to increase capital charges rather than force through the structural changes outlined by U.S. President Barack Obama.

Myners called on bankers and other market participants to give their views to his fact-finding excercise which follows concerns from investment market users.

"High frequency trading is an increasingly prominent feature of markets and so I find it an area worthy of attention,” Myners told reporters.

It refers to lightning fast, computer-driven trading which accounts for 60 percent of total equity volumes in the United States though Europe is further behind. [ID:nN24314255]

Critics say it causes wild price fluctuations but supporters point to greater competition and liquidity. The U.S. Securities and Exchange Commission is probing high frequency trading, putting pressure on its European counterparts to follow suit.

“People are coming to me, both market users and intermediaries saying that they have concerns about high frequency trading and so I should listen to those concerns,” Myners said.

“High frequency trading is a very new development. Does that have consequences that regulators need to be focusing on?” Myners said.

  The European Commission said on Monday it will also be included in a review of European Union share trading rules known as MiFID.

FSA warns on stock "spoofing"

The market regulator, FSA, said on Tuesday it will fine or suspend market operators involved in manipulation practices known as "spoofing" and "layering."

The warning follows a 35,000 pound fine imposed last year by the London Stock Exchange on an unidentified firm.

Spoofing and layering involve putting apparent trades on share order books to create a misleading impression of the stock price or liquidity. They both constitute potential market abuse, an LSE spokesman told Reuters.

Spoofing involves using systems' "direct market access," or DMA, which can offer investors like hedge funds, fund managers and private investors -- whether regulated by the FSA or not -- access to a stock order book. In a spoofing case, a trader gives the impression to put in a buy or sell order it does not want to complete to drive down the stock's price.

Most investment banks offer DMA solutions to some of their clients, the LSE spokesman said.

Layering consists of submitting multiple orders, typically on one single stock, to create the impression the share is highly liquid.

The LSE already warned on the practices last year, the spokesman said.

A spokeswoman for the FSA told Reuters: "We are not just saying: 'We are watching you.' We are warning to stop and if they do not, we will take action".

Global penetration of high frequency trading

Australia consolidates real-time trading oversight in regulator

Source:Reforms to the Supervision of Australia's Financial Markets Treasurer of the Commonwealth of Australia, August, 2009

"The Treasurer, Wayne Swan MP and the Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen MP, today announce changes to the supervision of Australia's financial markets that will enhance the integrity of Australia's financial markets and take another step towards establishing Australia as a financial services hub in the region.

The Government has decided to provide for the Australian Securities and Investments Commission (ASIC) to perform supervision of real-time trading on all of Australia's domestic licensed markets. This change will mean that ASIC will now be responsible for both supervision and enforcement of the laws against misconduct on Australia's financial markets.

'Australia's financial system has performed better than any other during the global recession and these reforms will ensure that Australia's regulatory arrangements remain among the best in the world,' Mr Swan said.

'As part of the Government's drive to improve regulation of the financial industry, the Government has decided to transfer supervisory responsibility for Australia's financial markets to ASIC as it is more appropriate for an agency of the Government to perform this important function,' Mr Bowen said.

The present arrangements require individual financial markets to self-supervise trading on their individual markets.

This reform is in line with the move towards centralised or independent regulation in other leading jurisdictions.

'Having one whole-of-market supervisor will consolidate the current individual supervisory responsibilities into one entity, streamlining supervision and enforcement, and providing complete supervision of trading on the market,' Mr Bowen said.

'Moving to whole-of-market supervision is also the first step in the process towards considering competition between market operators.'

The changes will mean that ASIC will become responsible for supervising trading activities by broker participants which take place on a licensed financial market, while individual markets – such as the Australian Securities Exchange (ASX) - will retain responsibility for supervising the entities listed on them.

'The supervision of listed entities raises a different set of issues. The Government is comfortable that there is no need for the Government to supervise listed entities. ASIC and the ASX are working well together in performing this role,' Mr Bowen said.

It is intended that legislation will be introduced into Parliament next year to give effect to this change, with ASIC to begin performing these functions in the third quarter of 2010."

This report relates to the period 1 January 2008 to 31 December 2008.

Accordingly, it does not address the Government announcement of 24 August 2009 on proposed structural changes to the supervision of Australia's financial markets.

ASX group will continue to have its current supervisory responsibilities for its markets and clearing and settlement facilities until at least the end of the next period for assessment purposes.

HFT goes global

High-frequency stock trading is spreading around the world into more and more asset classes, but progress is being slowed by poor infrastructure, heavy regulation and opposition from entrenched interests.

In some major markets in Asia, it can take seconds to execute an equities order. That's a lifetime for a trader who uses sophisticated algorithms to trade thousands of shares in a millisecond with the aim of earning a profit from market making and price imbalances.

Turf battles between exchanges also sometimes prevent the kind of interconnected market approach that provides fertile ground for high-frequency trading. Traditional brokers and institutions, whose positions are threatened by upstart trading houses, also help to erect barriers.

But the high-frequency wave, estimated to be responsible for about 60 percent of U.S. stock trading, has already washed over much of Europe and is being felt in some emerging markets, particularly in Latin America.

It is also making inroads in futures, options and foreign exchange.

In Brazilian stocks, there are signs that high-frequency trading is starting to get a grip, and some relatively small markets like Mexico and Colombia are encouraging major U.S. trading firms to bring in their latest rapid-fire trading techniques.

Smaller markets are attracted by the promise of more liquidity, which can make investing and trading cheaper and easier for everyone and help those who want to raise capital.

Concerns about algos gone wild setting off a market panic are secondary.

"It's a virtuous circle. The more people come, the more other people want to come," said Martin Piszel, head of alternative execution services at CIBC World Markets, the investment banking arm of Canadian Imperial Bank of Commerce.


In some European stock markets, high-frequency trading is already responsible for more than a third of all trading, according to several estimates.

The electronic wave has dramatically narrowed spreads and driven down trading costs, opening up some markets like never before.

Still, Asia, while having a lot of potential, is far behind.

"The regulatory environment in the U.S. and Europe, which is geared toward best execution, does not exist in Asia," said Takayuki Saito, head of direct execution sales at UBS AG's Asia-Pacific division..." (see article link for more)


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