Market Data Firm Spots the Tracks of Bizarre Robot Trading

jamie spotted a fascinating story at The Atlantic about "mysterious and possibly nefarious trading algorithms [that] are operating every minute of every day in" the stock market: "Unknown entities for unknown reasons are sending thousands of orders a second through the electronic stock exchanges with no intent to actually trade. Often, the buy or sell prices that they are offering are so far from the market price that there's no way they'd ever be part of a trade. The bots sketch out odd patterns with their orders, leaving patterns in the data that are largely invisible to market participants." Spotting the behavior of these bots was possible by looking at much finer time slices than casual traders ever see — cool detective work, but as the story points out, discovering it is just the beginning: "[W]e're witnessing a market phenomenon that is not easily explained. And it's really bizarre."

Comments

Re:Here's an explanation for you:

[Wonko the Sane]

Karl Denninger has been reporting this problem for a few years now.

Re:Here's an explanation for you:

[stonewallred]

The weird robot trades are actually preliminary account trades being done by a rogue AI who is marshaling its resources to better conquer and destroy all flesh based life. In about ten years, if there is any humans left who can access or spend time to look at the remaining data, will see the pattern. As a traveler from an alternate universe, I am giving you this warning to save yourselves.

The reasons are actually well known

[brian0918]

I've seen this reported on Zero Hedge for months now. The purpose of spamming the market with order quotes is to slow down the competitor's computers, to give you a slight edge in monitoring the market. Basically, you flood the market with order quotes. The competitors' algorithms have to take these into account, while your algorithm can be designed to ignore them. This gives you a slight edge over the competitors in processing actual market data and making determinations.

Re:The reasons are actually well known

[brianerst]

It actually doesn't need to be that nefarious (of course, it could be).

You see a lot of this sort of thing in the derivatives markets (I work in the industry - I was the lead architect of the CBOT's Order Routing System) and it's caused by auto-spreaders. A spread trade in derivatives involves finding a pattern between two or more products and trading the differential in prices (e.g., the March Corn contract and the June corn contract tend to move largely in sync, but the spread between them can grow and shrink, so you combine a buy and a sell when the spread narrows and a sell/buy when it grows again).

Most of the easier kinds of spreads are handled natively by the exchange trading engines - they imply prices into and out of the underlying contracts and trade the package of contracts as an atomic unit. But someone who wanted to trade non-standard spreads (like those across exchanges, for instance NYMEX energies vs. ICE energies) has to do it differently - you have to create a synthetic spread by watching the prices of the underlying products and "legging in" the different products you want to buy or sell when your price target is reached.

The easiest and least sophisticated way to do this is to wait until your prices all line up (say you want to buy the NYMEX Oil contract for 10 cents less than you sell the ICE Oil contract for) and then throw in market orders. Then you wait for the spread to move and throw in market orders when you're in the money (you sell the NYMEX Oil contract for 12 cents more than you buy the ICE Oil contract for). Bingo - you make money and you don't really care what either contract was really "worth" - you just care about the differential.

Problem is - market orders suck. The price can move away from you (screwing your differential) and you end up behind all the limit orders that were in before you (increasing your chances of a price movement). So, the smarter way to do it is to place part of your order into the market as a limit order that tracks against the price of the other market. As that market moves, you cancel/replace the leg or legs that are "in the book" so that you stay in sync with your overall strategy. If your "in the book" order(s) starts to fill, you know you've hit your target and you can drop the final part of your spread into its market, giving you a much better chance of getting your differential.

Now, imagine that you are doing a pretty complicated spread (four or five different underliers that all relate in some model you have) - depending on which ones you put into book and who else is spreading slightly different contract combinations, you get a lot of weird orders being inserted, canceled and replaced at prices all over the map. It can appear semi-random, but for each algorithm, it actually is highly deterministic.

I don't know if that's what's going on here, but I wouldn't necessarily rule it out. A number of exchanges (including the CME) are trying to stop this sort of thing, because the transaction volume going into and out of the exchange (and the associated price changes that need to get pushed out) is hugely expensive. So, these days you have to maintain a certain ratio of orders to fills (i.e., don't cancel or replace a lot) or you start to get fined.

Re:Nope, it's right on

[bertoelcon]

Why should Americans have all the fun? Could be Chinese bots... I hear they like money, also...

Lower ping times helps these bots a lot.

Re:Nope, it's right on

[mestar]

I don't see what is the mystery here. If two people are negotiating a price, and both of them have a hidden high/low price for which they are ready to settle, then the dominating strategy in a game theory sense is to move your price by the smallest step possible. That way, you always hit your opponents price that is best for you and worst for him.

Of course, in face to face markets, this is insulting:

http://www.youtube.com/watch?v=3n3LL338aGA

but, we are talking bots with a really low ping here. And that's what those patterns are.

At least those with increasing prices by one cent. Those where the bids are going down don't fit this explanation.

Re:I mostly agree! But let's soften it a little.

[afabbro]

Once you abandon the idea that the market gives a damn about the solidity of retirement accounts or the portfolios of the masses,

Easy to "abandon," since that was never the purpose. The stock market exists to marry investors' capital with business opportunities and to provide an easy means for selling and buying ownership shares of corporations. Corporations use the stock market to raise capital. Individuals or organizations use it to buy/trade ownership of corporations. That's it.

The stock market is not designed to be a retirement savings device.

Re:Free Market = good; Capitalism = Usury

[DougF]

Please read the Parable of the Talents, as told by Jesus in Matthew, chapter 25, starting at verse 14. Interest/usury was only forbidden against other Jews in the Old Testament. What you do with your money, how you treat God's gift to you, is the point. If God has blessed you with the ability to make money, legally and fairly, and you use that to do God's will (help the poor, build up his church, feed the hungry, send missions to the ends of the Earth, etc), then you are to be praised. If you just hide your talents (literally and figuratively) under the bed, then you reject God's blessings and reject His confidence in you to do His work. I also refer you to 1Corinthians 10:23, ("Everything is permissible"-but not everything is beneficial. "Everything is permissible"-but not everything is constructive). We have the freedom as believers in Christ to use the talents God gives us as we think best serves God's plan (hopefully with lots of prayer for guidance), but we need to ensure it is beneficial and constructive, and seeks the good of others. Therefore we don't have to worry about proscriptions on types of foods, or interest, or the other rules of the Old Testament, as that covenant has been fulfilled. We have a new covenant in Jesus Christ. 2Corinthians, Chapter 3, verse 6: He has made us competent ministers of a new covenenant-not of the letter but of the Spirit; for the letter kills, but the Spirit gives life." Unless, of course, you are Jewish, then the old rules still apply...

Re:High Frequency Trading Should Be Banned

[khallow]

In the absence of sensible regulation there are many abuses of the "free market" that effectively destroy it and turn it into a rigged game to benefit the already rich and powerful. Monopolies. Cartels. Price fixing. Trading on one's own account ahead of a customer.

Or we could do nothing and not fix a non-problem. After all, the market currently is far from "destroyed". "Monopolies, cartels, price fixing, trading on one's account ahead of a customer"? If any of those exist (for example, there aren't any monopolies resulting from high frequency trade), then all you have to do is develop your own high speed market program and profit from the opportunity. Or only trade with brokers that have passed some sort of fairness audit (if you desire fairness over profit).

These special access high-speed connections to the stock market exchange are market fixing tools, pure and simple. They allow the trading firms to skim the market for their own profit, thus defrauding every market participant in the world who lacks these powerful and privileged tools.

Once you strip the needlessly negative connotation from the above statement, it reads a bit differently:

These special access high-speed connections to the stock market exchange are market making tools, pure and simple. They allow the trading firms to provide, for a profit, extremely short term liquidity and price information, thus aiding every market participant in the world who is trying to sell large orders and who lacks these powerful and costly tools.

Requiring all buys to be held for a "long" time (a minute?, an hour?) would kill a lot of these shenanigans. Also requiring the link to go through a regulated buffer that introduces a random delay of a second or so would also take the wind out of their sales (pun intended). Or maybe we just impose a fee on each transaction so that they aren't free. Sub-millisecond trading loses a lot of luster if you automatically incur a charge equal to 0.1% (or something) of the stock's value.

Why would we want to kill these "shenanigans"? And why do you think a delay would stop the shenanigans (rather than introduce bizarre oscillations and such into the stock market).

Re:Nope, it's right on

[pyite]

Hell, even Jersey bots are out of luck.

NYSE (Arca) is already in Weehawken, NJ, and everything (including NYSE proper) is moving to Mahwah, NJ, beginning Monday, 2010-08-09.

Re:Nope, it's right on

[Princeofcups]

At least those with increasing prices by one cent. Those where the bids are going down don't fit this explanation.

And that is what this junk is, completely bogus bids with no intent other than to cost your competitors clock cycles.

I worked for a couple of years at one of the big trading exchanges in Chicago. Our offices were on a lower floor, and whenever our traders got off the elevator, coming back from lunch, they would hit all the floor buttons to delay the traders returning to the higher floors, and anyone else unlucky enough to be on the same elevator. But that was one of the minor reasons that I quit that business sector. The piles of spilled cocaine on the bathroom floors, and my boss asking me "Do you love money? I love money. In order to be in this business you have to love money!" were two others.