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SEC Blames Computer Algorithm For 'Flash Crash'
Lucas123 writes "The US Securities and Exchange Commission and the Commodity Futures Trading Commission today issued an 87-page report (PDF) on the results of a months-long investigation into the May 6 'flash crash' that sent the Dow tumbling almost 1,000 points in a half hour. The Commissions are holding a single trading firm's automated trade execution platform responsible for the crash, saying it dumped 75,000 sell orders into the Chicago Mercantile Exchange over a period of minutes causing an already volatile market to come crashing down. The SEC has already enacted some quick rules to pause trading if a stock price should rise or fall by 10% in a five minute period, but the regulators said they expect the results of the investigation to prompt additional rules limiting the functions of automated computer trading systems."
Not quite. A stock's quote price is the last price at which a bidder's offer matched a seller's asking price. A "level 2" quote has two parts, the highest bid price that hasn't been matched up yet, and the lowest asking price that hasn't matched up yet. The true value is somewhere in between these two, but nobody knows where until somebody steps in between the high bid or low offer or somebody moves their price to get a deal. Any computer programmer should check that there's matching orders on the other side of their trade before placing a large order. A program that doesn't will execute just fine, but crash the economic system.
It was a Solaris backend using a database on Linux that had a Java front end on a Windows PC. The trader monitoring the system was watching porn his Macbook Pro and didn't notice when things went kaflooey.
RIP America
July 4, 1776 - September 11, 2001
But if a large organization wanted to sell stock to itself at increasingly higher or lower prices there isn't anything you can do to stop it. It's illegal as hell but hard to prove.
the only thing that makes prices rational is a fluid market.
A low volume market produces irrational prices and makes it easy to move prices around inside the limits of rational prices.
Put it this way...
Millions of baby boomers are locked in on a large chunk of their retirement money at 14,000 dow.
As they get older that price they are willing to accept to cash out is degrading (a lot of boomers would cash out immediately if the market got above 13,000 now).
As long as the price doesn't get too high or too low, the boomers are paralyzed and the market is not fluid.
In 2012 to 2016, that price will degrade more. I think we have a decade of overhead pressure from boomers cashing out. At some point, the price won't matter- they'll *have* to cash out to pay bills or go back to work (oh yea, you can't really find work if you are in your 60's these days- I mean 50's.)
She was like chocolate when she drank... semi-sweet at first and then increasingly bitter.
Except that stock speculation has NOTHING to do with investment anymore. Wall street does NOT invest, it speculates. It is gambling on the minute by minute perceived loss and gains in the world with a hefty amount of making events happen.
Take the recent event of a speculator simply buying up chocolate to drive up the price. What has that got to do with investment or making money go around? Nothing at all.
You have the idea that the stock market is still the old idea of buying a share in a ships voyage when this was first made official in Holland centuries ago.
Yes, if you buy shares in a company hoping to get dividend from it in the future, then you are investing. When you are shorting stocks on the difference in value over a period of minutes, that is NOT investment.
Stop pretending that it is.
MMO Quests are like orgasms:
You may solo them, I prefer them in a group.
I just finished reading through the whole report. It's fascinating, if you're into this.
First, none of this involved a "bug" . All systems involved functioned as designed.
What's going on here is a logical consequence of the way the markets are set up. The Chicago Mercantile Exchange ("CME", the futures market, which started by trading grain) has a tradeable commodity called the "E-mini", which is a derivative security based on the S&P 500 stocks. Anyone can buy or sell contracts in E-minis, and can also buy or sell the underlying stocks. This generates a frantic amount of short-term trading from market players trying to profit from the differences between the two, which keeps the price of the E-mini close to the prices of the S&P 500 stocks.
None of this is productive activity, of course.
There's a consolidated feed from all markets that everybody gets. It has a few seconds of lag. To obtain an advantage in fast trading, some of the players buy direct exchange feeds with an average of 8ms (yes, 8 milliseconds) of lag.
What started the crash was that a fundamentals trader (one who actually pays attention to the companies involved) was selling $4 billion in stocks. Ordinarily, this isn't a big deal. They had a program throttling their rate of sale to 9% of market volume in the last minute, to avoid depressing the market. That's normal. So far, so good.
However, in response to this sale, the "high-frequency traders" started frantically trading back and forth to balance their portfolios. Their net effect didn't move prices much, but it pushed volume up. So the big seller started selling faster.
This generated enough volatility that some market players started dropping out, decreasing liquidity. That generated market imbalances which other traders started to exploit. Then, because of all this frantic trading, the consolidated market feed and the millisecond feed differed enough that some trading firms had data quality alarms and dropped out of trading. Since traders who are "market makers" are required to maintain buy and sell bids in the market, they defaulted to their default bids - buy at $0.01, sell at $100,000. Some trades actually took place at those prices. 895 shares of Apple stock were sold at $100,000. The price of Accenture fell from $30 to $0.01 in seven seconds, then recovered within the next minute.
Then "At 2:45:48, trading on E-Mini was paused for five seconds when the CME Stop Logic Functionality was triggered in order to prevent a cascade of further price declines". Yes, a 5-second automatic trading halt. That was enough to start to stabilize the E-mini contract trading on the CME. But by then, the E-mini was enough out of sync with the underlying stocks (mostly on the NYSE) that trading on the NYSE started to move stocks there to resync with the E-mini.
The NYSE still has a trading floor, which slows it down. This didn't help. But that's another story.
Nothing failed. Nobody did anything wrong. The original seller's strategy for unloading $4 billion in stock was reasonable. This is all a consequence of normal market operation. The report concludes that speeding up the consolidated market feed to get the 5-second lag (which was more than fast enough before program trading) down should be done. That's it.
Whether or not society should support an "efficient market" system to this extent is an question one is not supposed to ask.
Here are few important facts:
1. Waddell & Reed is the company whose aggressive selling triggered drop in S&P 500 futures price. The company is not HFT shop but rather long-term investment hedge fund. More here: http://www.bloomberg.com/news/2010-09-30/waddell-reed-e-mini-trades-are-said-to-have-helped-trigger-may-6-crash.html
2. According to SEC report, HFT traders played their intended role: smooth out short-term price volatility. However, due to enormous size of Waddell & Reed selloff (about $4 billion dollars in 75000 futures contracts during 20min.) they can do only that much. W&R just cut right through the order book on CME.
3. Slowing down the trading on NYSE did not help but rather hurt by locking up liquidity. Shitty NYSE Arca systems that handle ETFs overloaded and further exacerbated the problems.
4. At the end of day market returned to pre-crash levels. Long term investors were not hurt, W&R payed between 100 and 200 millions for their mistake.
5. Overall, market worked as expected.
The algorithm didn't fail, Wall Street as an institution has failed. The simplistic view of why capitalism works is that individuals and institutions making informed decisions results in good allocation of resources. The profitable thrive and the unprofitable die, and on the whole society benefits.
None of the preconditions for capitalism exist in the current setup. The big entrenched special interests change the nature of the system so that they take profit and are shielded from risk. The technical term for this is "moral hazard". The TARP bailout is the perfect example of this. All the big Wall St. firms made huge amounts of money by playing insider games with mortgage back securities (MBS) and collateralized debt obligations (CDO), and then when their gambling resulted in failure, the were bailed out to the tune of ONE HALF TRILLION DOLLARS, and the government is left with the bad assets. And the people who caused the mess are still in charge and got to keep all the money they stole during the bubble, as well as the money they got from the Treasury. Does the phrase "moral hazard" seem sufficient to describe this behavior, or would "rape, pillage and burn" seem more appropriate?
Programmed high frequency trading (along with hedge funds) are another mechanism for taking wealth from the system that breaks the capitalistic model. The claim is the it "increases fluidity" and therefore make the market "more efficient". The plain English translation of "more efficient" is theft, and "increases fluidity" is like saying "magic pixie dust".
The real world value of a company cannot change at millisecond resolution. The only things of economic value that change that fast are electronic abstractions of money. Therefore, high frequency trading is completely disconnected from real world value, so no capitalism is involved. The system is built so that insiders can become personally wealthy because they are the insiders, not because they do an efficient (good) job of allocating resources and benefiting society.
This is identical to the MBS/CDO monstrosity, in that there is no clear real world description of how value is created. For MBS/CDOs there was a lot of math that no one making decisions really understood, but somehow mortgages from buyers who were previously unqualified could become AAA securities. For flash trading there is "fluidity" and algorithms that traders don't understand. It is the same kind of scam.
As long as the stock market allows high frequency trading it will be intrinsically unstable, because this kind of trading is about manipulating the abstract system, not about real world issues. No set of rules will change things, because computationally based trading is about taking advantage of rules to get advantage via manipulation.
The only kind of rule changes that will help are things like increasing the cost of individual trades or keeping electronic traders from placing trades that they cannot or do not intend to make. (Trading algorithm determine price points by placing lots of orders and seeing which ones get responses.) Or electronic traders must be forced to honor trades or hold assets that they are trading, so they are exposed to the market risks of the underlying securities. Right now there is no cost for these traders for any manipulative practices, which effectively decouples risk from reward. All these kinds proposals move this kind of trading back towards actual capitalism.
It will be very hard to get meaningful changes to high frequency trading because the powerful and personally corrupt Wall St. insiders don't want a capitalistic system, they want their guaranteed profits. It is much closer to a Mafia style protection racket then a system that enables real business activity.
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