Tuesday, February 21, 2012

Murmuration and High Frequency Trading

"Oh, shite!"
Is murmuration just herd mentality, speeded up?  And if so, can it be compared to high frequency trading, ie. buying securities, speeded up? The following, from Nanex, shows that, yes, HFT is fast - but it lacks (crucially) the crash avoidance that starling flocks exhibit in murmuration: "High Freak Volatility: An example of HFT causing explosive volatility. On October 3, 2011, beginning at 11:10:00.450, [that's 450 thousandths of a second after 11:10 am] in the stock of CA Technologies (symbol CA), a bizarre interaction between multiple HFT algorithms caused a wild oscillation with over 1,000 trades executing in a 30 cent range. Just before and after the event, the bid-ask spread was a narrow 1 cent, and trades executed normally in a 1 cent range. Essentially HFT caused the bid-ask spread to widen from 1 cent to 30 cents in the blink of an eye. During the event, the quote rate exceeded 25,000 quotes/second, which caused significant quote delays of up to 1/2 second for this stock (and probably others processed on the same exchange equipment). Note that this is similar to an event which occurred in YHOO that we described as HFT trading faster than the speed of light (satire). The one question that needs to be answered and addressed: Why are trades printing with earlier timestamps than the orders (quotes) on which they were executed? Up to 1/2 second earlier, which we have been told is an eternity these days." Good question.  Trades happening before they're ordered?  Half a second is an eternity?  What the hell are exchange managers thinking?  To my mind, High Frequency Trading is exceedingly dangerous to the worldwide financial system, and could lead to more bizarre events like the Flash Crash of May 6, 2010.  (A July, 2011 report by the International Organization of Securities Commissions (IOSCO), an international body of securities regulators, concluded that while "algorithms and HFT technology have been used by market participants to manage their trading and risk, their usage was also clearly a contributing factor in the flash crash event of May 6, 2010.")  It is grossly unfair to traders, not only requiring specialized high speed trading gear, but also because it depends on geography - in that the closer your computer is to the trading floor the faster your connection is.  (There are now specialized firms that pimp HFT hardwire connections to exchanges to get even greater speed.)  Finally, as shown above, when algorithms of competing machines clash, the results can be weird to say the least, and potentially catastrophic in my view.  If exchanges ever want "retail" investors - and day-traders outside the NYC and Chicago  areas - back in the market, HFT must be banned outright because it distorts the system.