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Posts Tagged ‘New York Stock Exchange’

Ex-Physicist Leads Flash Crash Inquiry

In High Frequency Trading, Law & Regulations, Quantitative Finance, Technology, Trading software on 21.09.10 at 12:57

As a doctoral candidate in physics two decades ago, Gregg E. Berman spent most of his time in a laboratory searching through subatomic data for an elusive particle called the heavy neutrino. Today, from his office at the Securities and Exchange Commission, the former physicist is supervising a team of more than 20 investigators who have spent the last five months scrutinizing stock-trading data interview transcripts in an effort to figure out why stock prices went into free fall for 20 terrifying minutes on May 6th.

“What everybody would love to hear from the SEC is that XYZ trader blew up the market and made a gazillion dollars and is now in jail.”

Larry Tabb

Gregg E. Berman, head of an inquiry into the crash, said he will show how conditions and events led to an abrupt drop. (Photo: The New York Times).

Their long-awaited report on the so-called flash crash, in partnership with the Commodity Futures Trading Commission, is due to be published in the next two weeks, the New York Times reports.

Mr. Berman (44) will not say exactly what will be in the report, but he says that it will not simply restate what regulators have already said — that markets were volatile because of worries over the debt crisis in Europe, causing some computerized trading programs to stop trading, and finally causing computers on other exchanges to misread the pullback as a rapid bidding down of stock prices.

Instead, he says, the report will focus on a specific sequence of events that preceded the crash.

He says it will tell a clear story about what happened in the markets on that stomach-churning day, beyond simply pointing a finger at the perils of the kind of high-speed computer trading that dominates today’s markets.

“The report will clearly demonstrate how market conditions and events prior to the flash crash led to the extreme price moves.”

Some blame the high frequency trading for the so-called "flash crash" on May 6th.

When pressed, he adds, notably, that he had found no evidence of a deliberate attempt by anybody to disrupt markets.

The implications of the report are not merely academic.

Ordinary investors, shaken by the brief stock plunge and the lack of an official explanation, have withdrawn money from stock mutual funds every week since the crash.

Market analysts say investors want to be reassured about the integrity of the nation’s markets so they can be confident that a nose dive will not happen again.

The Berman report will not be the final word on the matter. Its findings will be used by a group of advisers to the S.E.C. and the commodity futures commission, which will make policy recommendations.

Still, some analysts question whether the report can deliver a simple answer that will satisfy everyone eager for reassurance.

“What everybody would love to hear from the S.E.C. is XYZ trader blew up the market and made a gazillion dollars and is now in jail,” says Larry Tabb, chief executive of the Tabb Group, a specialist on the markets.

“The answer, I think, is much more complicated and nuanced and has to do with a lot of different things. I am not sure that everybody outside the industry is going to have the patience to understand that.”

Mr. Berman acknowledges that his team’s explanation will involve a number of things happening at once.

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It may strike many people as painfully complex, but that is an undeniable result of the byzantine nature of today’s disparate electronic markets and the many players who take part in them.

The report’s conclusions will involve “market participants doing very different things and for very, very different reasons,” Berman says.

Central to all of this is the fact that stock trading is no longer centralized but instead takes place on dozens of exchanges, all with varying policies and procedures.

For example, the New York Stock Exchange has circuit breakers that prevent stocks from rising or falling so quickly that they disrupt the broader market.

Trading was slowed on several listings on that exchange on May 6, while other markets kept trading lower.

That lack of coordination created confusion during the flash crash.

Since then, the SEC has extended circuit breakers for individual stocks across all markets.

In investigating the crash, Mr. Berman says he finds himself in a position similar to his physics work 20 years ago, when he was collecting huge amounts of data and comparing the competing views of many laboratories on a question dividing particle physics — whether the neutrino, one of the least known and most common elementary particles, actually had mass.

Today he finds himself in familiar territory, sifting through huge amounts of messy and disjointed data, and at the same time reading blogs and e-mails from a wide range of observers, each with a theory about what happened on May 6th.

Read the rest of the article at The New York Times.

Related by The Swapper:

May 6. 2010: “The Black Thursday”

SEC Expand Single Stock Circuit Breakers for Russell 1000 Index And Others

Wall Street Collapse: Did Somebody See It Coming?

David Rosenberg: “The Weirdest 20 Minutes Of My Life”

U.S. Stock Crash Compels Further Investigation of Wall Street Scam

Testimony Of A High Frequency Trader

The Ultimate Trading Weapon

The Rise Of The New Market Makers

US Stock Markets Infected By Malicious Software?

Update: Day Traders Crack The Timber Hill Trading System

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Jm Cramer Shoot Down The Hindenburg Omen

In Financial Markets, Health and Environment, International Econnomic Politics, Views, commentaries and opinions on 21.08.10 at 01:33

Not only did we just have a second, and far more solid Hindenburg Omen confirmation today, with 82 new highs, and 94 new lows, but the Saturday is the day when Iran launches its nuclear reactor, and everyone will be very jumpy regarding any piece of news out of the middle east.

CNBC Host Jim Cramer

As for the Hindenburg Omen, the more validations we receive, the greater the confusion in the market, and the greater the possibility for a melt down (or up, as the case may be now that the market is unlike what it has ever been in the past).

Furthermore, with implied correlation at record levels (JCJ at around 78), any potential crash will be like never before, as virtually all stocks now go up or down as one, more so than ever before.

Well, here’s CNBC‘s Jim Cramer having a bashing over the recent chatter of an impending crash:

Vodpod videos no longer available.

Wednesday’s Market Action As Predicted By Jim Cramer

Jim Cramer’s Web Company Investigated By SEC

Jim Rogers Says CNBC Is A PR Agency

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Wall Street: The First Hindenburg Omen Confirmed

In Financial Markets, International Econnomic Politics, National Economic Politics, Views, commentaries and opinions on 20.08.10 at 00:29

The feared Hindenburg Omen was Thursday confirmed in the US stock market as the number of new highs was 136, and new lows was at 69, according to The Wall Street Journal‘s interactive Market Data Center.

“The more confirmations, the scarier it gets from a technical perspective, not to mention the conversion into a self-fulfilling prophecy.”

Zero Hedge


The first omen was spotted on August 12th:The indicator may suggest a savage equity downturn is imminent,” the famous analyst Albert Edwards at Societe Generale said then. Today,  a week later, the Hindenburg Omen has been confirmed for the first time.

Last week’s plunge in US stocks triggered a technical indicator known as the Hindenburg Omen that may signal a more severe selloff.

See: Feared Indicator Warns Of Catastrophic Stock Market Event

The market signal, named for a German zeppelin that caught fire and crashed more than seven decades ago, occurs when an unusually high number of companies in the New York Stock Exchange reach 52-week highs and lows.

The indicator last occurred in October 2008.  The signal occurred seven times in 2008 as the S&P 500 posted its biggest annual drop since the Great Depression.

The Hindenburg Omen must be confirmed with a second occurrence within 36 days to raise the alarm.

And that’s what happened today.

Self-Fulfilling Prophecy

“The more confirmations, the scarier it gets from a technical perspective, not to mention the conversion into a self-fulfilling prophecy  – like every other technical indicator,” Tyler Durden at Zero Hedge writes.

In addition; it must also occur when the NYSE McClellan Oscillator, a measure of market momentum, is negative.

Well, today’s were the McClellan oscillator at NYSE was negative at -83.6.

According to Wikipedia this is the following criteria of the Hindenburg Omen, calculated daily using Wall Street Journal figures for consistency:

  1. The daily number of NYSE new 52 Week Highs and the daily number of new 52 Week Lows are both greater than 2.2 percent of total NYSE issues traded that day. Based on approximately 3100 NYSE issues, the 2.2% threshold is 69.
  2. The NYSE 10 Week moving average is rising.
  3. The McClellan Oscillator is negative on the same day.
  4. New 52 Week Highs cannot be more than twice the new 52 Week Lows (though new 52 Week Lows may be more than double new Highs).

“The traditional definition requires each condition to occur on the same day, and be repeated within a 36-day period.”

“The occurrence of all criteria on a single day is often referred to as an unconfirmed Hindenburg Omen, because the indicator has a high false alarm rate.”

An Imperfect Indicator

To eliminate false positives some technical analysts have imposed the condition that the Hindenburg Omen

  • must be triggered 3 times in a row within a month from the 1st triggering event for said initial trigger signal to be considered to be valid
  • is only valid when “all tightly coupled triggerings are within a fortnight
  • will indicate a possible future downturn or correction, depending on the magnitude of any “one off” triggering

The creators of the signal have not fully explained the selection of the threshold value of 2.2% of issues traded.

Because of the specific and seemingly random nature of the Hindenburg Omen criteria, the phenomenon may be simply a case of overfitting. That is, by backtesting through a large data set with many different variables, correlations can be found that don’t really have predictive significance.

The Omen is at best an imperfect technical indicator that is a work in progress, in  most analysts view.

Anyway – here’s Jim Puplava talking about the mainstream media and how they spin the economic news  – and Max Keiser talks about the Hindenburg omen.
Recorded on August 14th 2010:

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Feared Indicator Warns Of Catastrophic Stock Market Event

In Financial Markets, International Econnomic Politics, National Economic Politics on 15.08.10 at 15:00

This week’s plunge in U.S. stocks triggered a technical indicator known as the Hindenburg Omen that may signal a more severe selloff, according to analysts who follow charts to predict market moves. The market signal, named for a German zeppelin that caught fire and crashed more than seven decades ago, occurs when an unusually high number of companies in the New York Stock Exchange reach 52-week highs and lows.

“It’s an interesting name but what you really have as a technical background is a classic distribution phase in the market.”

Michael Riesner


The indicator last occurred in October 2008, according to UBS AG. On Friday yhe Standard & Poor’s 500 Index yesterday completed the biggest three-day decline since July 1, after an unexpected increase in unemployment claims added to evidence an economic recovery is weakening.

The benchmark gauge for U.S. stocks has dropped 3.4 percent so far this week as Federal Reserve policy makers said growth “is likely to be more modest” than they previously forecast.

The indicator may suggest “a savage equity downturn is imminent,” Albert Edwards at Societe Generale says. Edwards has told investors to favor bonds over stocks for more than a decade, according to Bloomberg.

“Equities are tottering on the edge as increasingly recessionary data becomes apparent. It would not take much to tip them over that edge.”

The Hindenburg signal was triggered yesterday as the proportion of stocks reaching new one-year highs and lows both exceeded 2.2 percent of the total listed on the NYSE, according to Michael Riesner, a technical analyst at UBS in Zurich.

The number of stocks at a 52-week high must not be more than twice the number marking lows, the technical theory also says, according to analysts.

The indicator is only valid in a rising market, as defined by the NYSE Composite Index’s rolling average value in the last 10 weeks.

It must also occur when the NYSE McClellan Oscillator, a measure of market momentum, is negative.

The Hindenburg Omen must be confirmed with a second occurrence within 36 days, according to Riesner. He says the signal occurred seven times in 2008 as the S&P 500 posted its biggest annual drop since the Great Depression.

“It’s an interesting name but what you really have as a technical background is a classic distribution phase in the market,” Riesner says. “It’s the classic tug of war between bulls and bears that you have there.”

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Norway's Oil Fund Among BP's Largest Shareholders As Bankruptcy Rumors Hit Market

In Financial Markets, International Econnomic Politics, National Economic Politics, Views, commentaries and opinions on 09.06.10 at 20:58

The BP stocks are getting bashed with a variety of rumors as to the cause.  One of the main triggers is a Fortune article, which quotes oil industry veteran Matt Simmons who says  BP has about a month left before they declare Chapter 11. Among the top 5 shareholders in the oil giant is the Norwegian Government Pension Fund.

“They have about a month before they declare Chapter 11. They’re going to run out of cash from lawsuits, cleanup and other expenses.”

Matt Simmons


At the moment the BP stocks are down by more than 11% at New York Stock Exchange. Speculation about a Chapter 11 filing is just one of several rumors buzzing around on Wall Street right now, an other is that BP has hired a bankruptcy lawyer. But this is still just speculations. However, day traders are probably having a great time!

In an article in Fortune Magazine, published at CNNMoney.com, the well known oil and gas industry insider, Matt Simmons, speaks with a bold voice and makes even bolder predictions.

For more than 35 years, Simmons has run a Texas-based boutique investment bank, Simmons & Co., which specializes in the energy industry. At times, with his somewhat doom-and -loom-like take on things, there’s a hint of conspiracy theorist in his tone.

But it’s hard to ignore that Simmons is deeply connected and has been pretty much right on in the past.

These days, Simmons has been weighing in on BP (BP) and the worst oil spill in U.S. history, following the explosion of the Deepwater Horizon drilling rig in the Gulf of Mexico.

As BP struggles to permanently stop the gush of oil, Simmons has been warning that the scale of the spill is much bigger and that there’s a larger leak several miles away.

On question of how he see the future of BP, he says:

“They have about a month before they declare Chapter 11. They’re going to run out of cash from lawsuits, cleanup and other expenses. One really smart thing that Obama did was about three weeks ago he forced BP CEO Tony Hayward to put in writing that BP would pay for every dollar of the cleanup. But there isn’t enough money in the world to clean up the Gulf of Mexico. Once BP realizes the extent of this my guess is that they’ll panic and go into Chapter 11.”

According to Zero Hedge, the other rumor which is gaining traction, is that BP has hired a bankruptcy lawyer.

But as ZH points out:

“Seeing how today was the 1,293,498th time the Radioshack LBO rumor pushed the stock higher, all this media rumormongering should certainly be taken with a blob of oil.”

Another Lucky Bet?

As it turns out; wherever there’s a bankruptcy, there’s Norwegian tax payers money involved.

Lehman Brothers, Greece, Spain, you name it….

More than 10% of the nearly NOK 3 trillion fund is invested in the PIIGS countries, and almost 50% are invested in the Chinese equity market who recently entered a so-called “bear marked.”

And when it comes to BP, the Norwegian Government Pension Fund Global is the fourth largest shareholder in the company with a 1,8% ownership.

Here’s the list of the top 10 BP investors:

The world’s biggest asset management company is based in New York and owns 5.9pc of the shares.

Legal & General:

The UK insurer and asset manager owns 4pc of the shares.

Barclays Global Investors:

The asset manager, which is owned by BlackRock, owns 3.8pc of the shares.

Norges Bank Investment Management:

The asset manager manages the money generated from Norway’s oil revenues and owns 1.8pc of the shares.

M&G Investment Management:

The UK asset manager, owned by the Prudential, owns 1.67pc of the shares.

Standard Life:

The Scottish insurance company owns 1.5pc of the shares.

Capital Research & Management Co:

The Los Angeles-based fund owns 1.3pc of the shares.

Insight Investment Management:

The fund manager owned by Lloyds Banking Group owns 1.13pc of the shares.

China’s State Administration of Foreign Exchange:

The body that manages China’s $2.4 trillion of foreign-exchange reserves owns 1.1pc.

(Data from Bloomberg as of June 3.)

Related by the Econotwist:

Norway At The End Of An Era

Norwegian Pensioners Enter Bear Market

Here’s The REAL Norwegian PIIGS Exposure

Evaluation Of Norwegian Monetary Policy

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6 U.S. Banks Collects 93% Of Industry's Trading Revenue

In Financial Markets, International Econnomic Politics, National Economic Politics, Views, commentaries and opinions on 09.06.10 at 19:05

Jepp, it’s the same big banks who have recivied the most of the bailout money. Of the remaining 1236 U.S, banks in 2008, 250 have gone bankrupt, the rest are not making any profit at all. About 700 of them is still in danger of being closed down by the regulators. And here’s an interesting question for you: Which of these banks would you trust the most in handling your money? The big ones? Or the smaller banks?

“If there’s one thing you should have learned during the past four years it is this. Large global commercial investment firms are about as trustworthy as a used car salesman.”

J.S. Kim


My guess is that we probably never will know the full truth about what’s been going on in the financial industry over the last decade. Most likely we have no clue on what is going on at the moment, either. But here are some facts; the three most profitable U.S, banks in 2009 was at the brink of collapse a year earlier, they’ve all recivied an unknown amount of bailout money from American tax payers and they are all under criminal investigation for alleged fraud and market manipulation.

The absurdity of the situation is becoming more clear every day.

The latest smelling evidence of a rotten system is to be found in the documents of the U.S. Security and Exchange Commission, based on the banks latest earnings reports.

As the figures below shows, the top 15 U.S, banks collected 97,8% of the total revenue in the American financial industry in 2009, mounting to USD 62,8 billion.

The remaining 986 banks had to share 2,2%, or USD 1,4 billion.

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* The top 6 bank holding companies have significant investment banking operations and account for 93% of industry trading revenue. 

* The next 3 bank holding companies are traditional trust and custody banks. Including those 3, the top 9 banks account for 96% of industry trading revenue.

* The next 2 bank holding companies are not community banks but rather an insurance company and an automotive financing company. Those 2 included, the top 11 banks accounts for 97% on industry’s trading revenue.

* The remaining 4 banks on the top 15 list account for less than 1% of industry trading revenue.

* The remaining 971 bank holding companies that filed FR Y-9C reports for the year ending December 31. 2009, and approximately 6.800 commercial banks accounted for the remaining 2,2% of the financial industry’s trading revenue.


51 Billion Dollar Profit (Of 60 Billion Revenue)

The top 6 bank holding companies made a total pre-tax profit of USD 51 billion in 2009.

The remaining 980 bank holding companies lost about USD 19 billion.

Moreover; aggregated 2009 trading revenue for the top 6 bank holding companies is USD 60 billion, and exceed their aggregated pre-tax income of USD 51 billion.

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Top 3 Criminals?

According to the original document the three most profitable bank holdings companies in 2009 were:

1. Morgan Stanley (Growth, y/y; 176,8%)

2. JP Morgan Chase (Growth, y/y; 127,3%)

3. Goldman Sachs (Growth, y/y; 61,3%)

Among the other top 6 banks, Bank of America had a marginal growth of 0,7% in 2009, while Citigroup and Wells Fargo had negative growth – around -30%.

And just to put a final touch on the picture:

Morgan Stanley and Goldman Sachs are now under criminal investigation, suspected of misleading investors and rating agencies in order to inflate the grades(ratings) of certain mortgage securities before the whole thing collapsed in 2008.

JP Morgan is being investigated for manipulation of the silver market.

This brings me to the question I asked at the top of the article; which one of these banks do you trust with your money?

It’s a kinda important question as a substantial number of banks (excluding those on the top 15 list) are about to disappear.

Since the “house of cards” fell apart in 2008, 250 banks have gone bankrupt and have been closed by the FDIC.

The regulators still have about 700 companies on their list of  banks in danger of default.

That makes it even harder to come up with a definitive answer.

However, J.S. Kim at SmartKnowledgeU has a very clear opinion.

3 Reasons to Cut All Ties with Commercial Banks

“If there’s one thing you should have learned during the past four years it is this. Large global commercial investment firms are about as trustworthy as a used car salesman,” Mr. Kim writes in his latest letter to clients.

Adding: “This has been the case since the birth of Wall Street, but people are only waking up to this reality today after the ugly secrets of the industry have finally been revealed to the outside world in the past several years. The lesson the public-at-large is learning today is one that old-school American gangster Lucky Luciano learned after spending a day on the floor of the New York Stock Exchange, an eye-opening lesson that allegedly induced him to comment: “I realized I’d joined the wrong mob.”

“In this article, you will be reminded of how firms bundled mortgages they knew were toxic into CDOs, sold them as solid investments to clients, and then shorted them behind their clients’ backs. You will further learn how under Congressional inquiry, only 25% of all investment bankers believed that it was their duty to act in the best interests of their clients. Sure, these bankers may tell you in face to face meetings that they always put your interests first, but according to their testimony in Congress, in reality, they think of you as a sucker more than anything else. Furthermore, I’m betting that more than half of the 25% of investment bankers that stated they should act in the best interests of their clients only stated this because they knew their statements would become part of the public record.”

“In this second article, you’ll be reminded of how JP Morgan somehow commingled $8.6 billion of their clients’ money with the firm’s own assets – an act that JP Morgan’s internal audits did not catch for seven years and an act that would have left their clients penniless if the firm had gone bankrupt during the time they did not separate their clients’ assets from the firm’s investments.”

“Finally, although almost every single US commercial investment firm adviser shuttles their clients that desire gold and silver into the paper ETFs GLD and SLV, I’m guessing that almost ZERO of these advisers properly explain the risks of the GLD and SLV, as paper proxies for real gold and silver, to their clients. Remember that bottom line profits to the firm from purchases of the GLD and SLV will be much higher than the zero profit that would result if clients opted to buy physical gold and physical silver on their own. As this third article explains, the probability is extremely high that these two funds will offer little of the protection that physical gold and physical silver will afford its owners, should the second phase of this monetary crisis progress in the manner we believe it will progress.”

Read the rest at TheUndergroundInvestor.com.

Related by the Econotwist:

Banks Face Multi-Hundred-Million Dollar Settlements

You Sue Me, I Sue You, Oh Peggy, Peggy Sue

Civil And Criminal Probes Against JP Morgan For Silver Manipulation

How To Create A 3 Trillion Dollar Bubble And Burst It

SEC To Take Action Against Moody’s

U.S. Stock Crash Compels Further Investigation of Wall Street Scam

The Truth, Some Truth And Something Like The Truth

Goldman Sachs Charged With Fraud – Here’s The SEC filing

Goldman’s Collateralized, Securitized And Synthesized Fraud

Obama: “It Is Time”

AIG: What Did FED Bail Out and Why?

EU Wants Answers From Wall St. On Greek Debt

Italy Charge Foreign Banks With Fraud

Where Exactly Is “Money Heaven”?

Organizing Financial Rebellion

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Testimony Of A High Frequency Trader

In Financial Markets, International Econnomic Politics, National Economic Politics, Views, commentaries and opinions on 08.06.10 at 12:36

The so-called “flash crash” at the New York Stock Exchange on May 6th was naturally one of the the main issues  at Golden Networking.net’s High Frequency Trading Leaders Forum 2010 last week. Among the key participants was Mr. Manoj Narang, founder and CEO of Tradeworx, one of the HFT firms that stopped trading on May 6th. Below is a transcript of the conversation between Mr. Narang and The Wall Street Journal‘s Scott Patterson that took place after the formal speeches.

“The market was ripe for a catastrophic event, because it was so saturated with stop orders, all it needed was a catalyst.”

Manjo Narang

“I want to call it Seis De Mayo because I believe it’s a vindication day for high frequency traders. I think that fingers were very quick to be pointed in the direction of High-Frequency Trading for this meltdown; I think that the post-mortem has not been written yet on this episode, but what’s abundantly clear is that like has been the case in every other crisis in recent memory, humans were intimately involved and fully responsible for this particular meltdown as well,” Mr. Narang said in his speech at the HFT Leaders conference.

After the speech, the following conversation took place between Manjo Narang and WSJ-reporter Scott Patterson who wrote a groundbreaking article on high frequency trading last year:

Read the full transcript at The Swapper.

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Testimony Of A High Frequency Trader

In Financial Engeneering, High Frequency Trading, Law & Regulations, Quantitative Finance, Trading software on 08.06.10 at 12:15

The so-called “flash crash” at the New York Stock Exchange on May 6th was naturally one of the the main issues  at Golden Networking.net’s High Frequency Trading Leaders Forum 2010 last week. Among the key participants was Mr. Manoj Narang, founder and CEO of Tradeworx, one of the HFT firms that stopped trading on May 6th. Below is a transcript of the conversation between Mr. Narang and The Wall Street Journal‘s Scott Patterson that took place after the formal speeches.

“The market was ripe for a catastrophic event, because it was so saturated with stop orders, all it needed was a catalyst.”

Manjo Narang

“I want to call it Seis De Mayo because I believe it’s a vindication day for high frequency traders. I think that fingers were very quick to be pointed in the direction of High-Frequency Trading for this meltdown; I think that the post-mortem has not been written yet on this episode, but what’s abundantly clear is that like has been the case in every other crisis in recent memory, humans were intimately involved and fully responsible for this particular meltdown as well,” Mr. Narang said in his speech at the HFT Leaders conference.

After the speech, the following conversation took place between Manjo Narang and WSJ-reporter Scott Patterson who wrote a groundbreaking article on high frequency trading last year:

Scott: I remember, before May 6th, one of the predominant themes that I heard, in defense of high-frequency trading, was that, in 2008, when everything is falling apart, that one part of the entire market that stood up was the equity market, and that was a defense made by high-frequency trading, and high-frequency trading took the credit for that. On May 6th, obviously, you saw a completely different market, that revealed structural problems. I dont think there’s really much argument that high-frequency trading traders pulling out added to…

Manoj: You wanna put the statement of high-frequency trading traders about the services they provide against them?

Scott: I want to see how you react. The issue is when you have chaotic markets…

Manoj: You know you are not going to get me on this one?

Scott: I know, you are ready for this one. You have a chaotic market that messes up the models, the data slows downs, a lot of high-frequency traders pull out, I know they did, I talked to a lot of them, you look at the order books, and they just completely evaporate. It wasn’t just high-frequency traders, everybody got out, you see this as a problem, when you have a group of traders who are  60% of the market, who are highly sensitive to chaotic markets, and when you have that, they pull out, and that makes the decision even more chaotic.  Is there a solution to that?

Manoj: I don’t think that’s a correct characterization. First of all, you are inferring that if humans would be running the show, they wouldn’t have pulled out. And that’s exactly what happened in 1987.

Scott: On the Big Board, they did slow down trades on May 6th, yet they had no cancelled trades. So you had a part of the market, which had human intervention, actually staying.

Manoj: And that was a critical part of what exacerbated the plunge, and let me explain why.

Scott: That’s not what the NYSE will say.

Manoj: Of course, they won’t say that, but I will; human intervention exacerbated the crisis. First of all, I will just reiterate that this crisis was precipitated by panic selling by humans. The reason why this happened was because was the market was in particular vulnerable state on May 6th. We just had had a huge run-up in the equities markets, we were in the midst of a 10% correction, even before the mayhem unfolded, and on top of that you had very vexing news coming out of Europe, lots of images on CNBC, people rioting in the streets in Greece, the prospects of the second phase of the crisis unfolding. In that sort of an environment, people tend to seed the markets with stop orders. That’s what happened in 1987, that’s what happened this time around. So, the market was ripe for a catastrophic event, because it was so saturated with stop orders, all it needed was a catalyst. And the catalyst occurred, according to a couple of Reuters reporters, because a large mutual fund complex, decided to do a $4.5B hedging transaction in e-mini futures contracts, which track the S&P 500 index, when the market was already in that vulnerable state.

Scott: Most of those were actually transacted on the way up.

Manoj: Right, but the orders were entered prior to the huge collapse, and that’s the important part. On an ordinary day, an order of that size, and that’s a pretty substantially sized order, would definitely have had a ½% or 1% price impact. But on this day, when volatility was already elevated, and the market was just looking for a reason to take profits, it had an outsize effect, and very likely triggered the first wave of stops, which then turned into market orders, which then led to a gigantic spike in volume. What happened then, in relatively short order, was that the Arca exchange (which is owned by NYSE), fell behind, in terms of its ability to process quotes. That’s not that unusual, that happens all the time, particularly with Arca. When that happens, faster exchanges, namely BATS and Nasdaq, are entitled to take a regulatory remedy, known as declaring called “regulatory self-help”. It means that the exchanges absolve themselves of their responsibility to route orders to Arca, at seemingly better prices, because they are declaring that those prices are steal and not real. After this, the Arca exchange ceased to be a functioning part of the market, effectively going offline. Shortly after that, NYSE made the fateful decision to take its exchange offline. Two of the biggest exchanges in the market were effectively closed for business, for a short period of time. In that sort of an environment, combined with the fact that all of a sudden, lots of stops were turning into market orders, what happens is that, because of the reduced liquidity, these market orders start slicing through the available liquidity, like a hard knife through butter, and there’s very little resistance in the way. Price formation in NYSE stocks is severely impacted, because, although NYSE itself has only 25% market share, it is still the primary price discovery market mechanism for stocks on the Big Board; you saw an impact that was far more pronounced in NYSE stocks. In fact, every stock that heavily declined, with one exception, was a NYSE stock. So that tells you of the wisdom of NYSE’s actions. So with half of the market offline, with clearly erroneous prices being transacted in the market place, certain high-frequency traders, myself included, made the decision that now it is not a good time to trade, because we are just going to exacerbate the problem.

So let me answer your question, Scott, by sending a question in your direction. When technology is not working, when system are screwed up, do you want the airline pilot to decide to take off, even though he knows his instruments are not working properly? I think the proper thing to do is to shut off. Really, the proper thing to do would have been for the exchanges to shut off, to prevent those erroneous prices to ever happen. NYSE’s decision would have been well-advised if there had been market-wide protocols in place to take a time out. But given that they weren’t, NYSE was extremely ill-advised to do that. Other things I would say:

First, you can ask why high-frequency traders were not there providing liquidity, when that’s their stated mandate, you can ask why high-frequency trading traders turned off when volatility was sky-high, given the contention that volatility benefits them. These are all valid questions, but you have to understand that strategies are not monolithic. People run different sorts of strategies.

A very common sort of strategy, Statistical Arbitrage, is a strategy that propagates price information from stocks that are moving to stocks that haven’t moved yet. It’s one of the primary mechanisms for liquidity transfer in the markets. However, what this involves is propagating price information. In an environment where the inputs are wrong, propagating this information is just going to exacerbate the problem. What I am trying to say is, if P&G is down 40%, it is not appropriate to propagate these values to other stocks, even though they are correlated to P&G. For those types of systems, the only responsible thing to do is to turn off because, even though they serve a very valuable function in an ordinary market, which is to propagate price information, on a cross-sectional basis, they are actually counterproductive, when the prices they are trying to propagate are clearly erroneous. So that’s the second point.

The third point I would make, and this is perhaps the most important point, is that liquidity really should be thought of as a commodity. It is a commodity, and in like any other market, it has supply and demand. Volatility is the symptom of the absence of liquidity. We saw that in May 6th, there was no liquidity, so markets were free to move in huge increments in short periods of time. What’s the relevance of what I am saying? In a supply and demand market, when there s a shortfall of supply or, equivalently an excess of demand, it becomes very profitable to be a supplier in the market. When oil prices are sky-high, producers of oil make a fortune. However, that does not imply that their activity exacerbates the mismatch between supply and demand, in fact, it does the opposite. So while oil producers are making money, oil prices being sky-high, by distributing oil into the market place, that tempers the price of oil and drives it back down by bringing the imbalance between supply and demand closer to equilibrium.

The same thing is true with liquidity. Liquidity is the opposite of volatility. When there is volatility in the market, it is because there is a shortfall of liquidity, there is a shortfall of high-frequency trading, because high-frequency trading is the backbone of liquidity in today’s markets. For that reason, when there is volatility, it becomes extremely profitable to be a high-frequency trader. Many of the folks that I know continued trading on that day had very profitable trades. Our own simulations in my firm indicate that we would have had a record day of profits if we kept trading. The reason we stopped, apart from the reasons we already mentioned, which were that two of the exchanges were down, and that price information shouldn’t be propagated if it is erroneous, we were also concerned about the risk of trade breaks. So if exchanges allow for these trades to happen (by the way, many thousands of trades were broken), so if you happen to buy at some of these prices, and then sell it at a higher price, and think that you made a tidy profit as a result of that, you can be sad to learn that your buy is broken but not your sell, and you actually finished the day short; if the problem is bad enough, you could actually violate your margin limits, and wind up with a huge overnight position that can’t be supported with the base of capital you are trading of.

So in those sorts of circumstances, even though you think you are going to earn a huge profit if you continue trading, it’s not responsible to do so, unless you are extraordinarily capitalized and can take that risk. So that’s the reason why my firm turned off, not because we didn’t want to be there providing liquidity, but the bigger point is that imbalances between supply and demand of liquidity, are driven by the demand side of the equation. What I mean by that is that, on May 6th, we saw a record number of shares changing hands. So clearly there was a lot of high-frequency trading going on. But also clearly, it was not nearly enough to sate the demand for liquidity. That because liquidity shortfalls are driven by the demand side, not by the supply side. Like any other supply and demand structure, the market cannot be assumed to be always in equilibrium. And there is no way regulators can force any market to be in equilibrium, that’s just purely a function of supply and demand. No matter what regulators do as part of liquidity obligations, no matter how much they force people to stay in the market, there will be times when herd-like behavior among long-term investors will all be stampeding for the exits at the same time,  and simply there won’t be enough high-frequency trading to cover the demand for liquidity. Like I said, liquidity crises are not driven by the lack of liquidity, but by the demand of liquidity. So, I hope that comprehensively answers, from a number of different perspectives, the question you asked, but also, why it is a bit misguided on the part of regulators to try to prevent liquidity crisis from occurring. In order to prevent liquidity crises from occurring, you would need to prevent herd-like behavior among long-term investors, because that’s what causes bubbles, and that’s what causes liquidity crises.

Related by The Swapper:

The Rise Of The New Market Makers

May 6. 2010: “The Black Thursday”

Wall Street Collapse: Did Somebody See It Coming?

U.S. Stock Crash Compels Further Investigation of Wall Street Scam

Welcome Back to Earth, Mr. Market

Living In A Derivative World

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