Saturday, July 25, 2009

Karl Denninger, "My View on HFT, High-Frequency Trading"

"My View on HFT, High-Frequency Trading"
by Karl Denninger

"Senator Charles Schumer asked the U.S. Securities and Exchange Commission to ban “flash orders,” saying the transactions give high-speed traders an unfair advantage over other investors. Nasdaq OMX Group Inc., Bats Exchange Inc. and Direct Edge Holdings Inc. hold these orders for milliseconds, giving their customers the opportunity to gauge demand before traders on other exchanges get the chance to bid, Schumer said in a letter to SEC Chairman Mary Schapiro. Brian Fallon, a spokesman at Schumer’s office, confirmed the authenticity of the letter.

“Flash orders allow certain members of these exchanges to obtain access to order flow information before that information is made available to the public,” Schumer wrote. That allows “those members to use rapid trading programs to trade ahead of those orders and profit from advanced knowledge of buying and selling activity,” he added. The senator said that if the SEC doesn’t prohibit flash orders, he will introduce legislation that would.

This is my view: Getting a look at orders before someone else does is commonly called "cheating". The National Market System (NMS) was supposed to prevent that; this was the so-called "innovation" of Nasdaq, remember? No specialists, no balancing of orders to open a stock, all done by computer. Equality of access. Up until it became profitable to make some people more equal. The intent of a public stock exchange is to insure equality of access to information so that the markets are orderly, not rigged.

Using flash order information (or anything else) to front-run is illegal. In all of its forms, this is an extremely serious matter and it must be stopped. To the extent that these HFT systems are in fact using flash (or other) traffic to get in front of orders and advantage themselves they are dramatically increasing the violence of market moves. A stock trading at $20 that has a bid come in with a limit of $20.10 would normally fill (assuming sufficient depth) at $20; this does not materially move the market. But if a HFT system "sees" that order, steps in front of it and buys up all the shares at $20 and then re-sells them to the customer at $20.04 (one penny better than the next best offer at $20.05) it has caused the current "last" price to move where it otherwise would not. Multiply this by millions of shares an hour and the impact on price moves could be tremendous. While I understand that many people like the move of the last two weeks in the market, the fact remains that what goes up can also come down with equal violence.

I call upon The SEC to conduct a full and public investigation of the HFT systems in use today, along with immediately banning the "flash" traffic in accordance with Senator Schumer's request. I specifically want to know:

Have any of these HFT systems been using flash traffic to "step in front" of a flashed order?
What part did these systems play in the October and March meltdowns, along with the ramp job of the last two weeks? Specifically, were they stepping in front of orders in these cases, thereby dramatically amplifying market moves while skimming off their pennies?
Public and fair markets demand transparency. All users must obtain access to order flow at the same time, without exception, and attempts to "step in front of the line" must be met with both civil and criminal sanction for market manipulation."
- Karl Denninger, http://market-ticker.denninger.net/

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