As regulators continue to look into the causes of the May 6th flash
crash, some high frequency trading approaches are coming under scrutiny. In
particular the concept of “quote stuffing”, where algorithms send so many
orders into the order book that the market cannot possibly respond, has come
under fire from market participants and the press.
The SEC, having reportedly decided that quote stuffing probably did
not have a major role in the flash crash, is now taking aim at the practice to
see if it puts some investors at a disadvantage by distorting stock prices (http://tinyurl.com/264kr3o).
The CFTC is looking at data from database developer Nanex and mulling how to
address quote stuffing in futures markets (http://tinyurl.com/3a7w7sv).
Meanwhile, concerning incidents continue to happen in the market. As
recently as last week there was an incident that caused Christopher Steiner at
Forbes to write a story called “Did
we dodge another flash crash on September 1st?” The story describes how on
September 1st at 10am quote volumes ballooned – as they did on May 6th.
In fact quotes reached 275,000 per second, as opposed to 200,000 on May 6th.
Unlike the flash crash though there wasn’t a dramatic fall in prices. However,
the bids and offers did cross for a time – leading to high frequency traders
taking advantage of arbitrage opportunities. This data was exposed again by
firm Nanex – and left the market wondering if quote stuffing by high frequency
traders was behind the spikes.
The world is waking up to the fact that high frequency and algorithmic
trading have quietly become part of the market fabric, and the world does not seem
to be too happy about it. HFT and algorithms are being "demonized"
said the FT article, and I agree. I also think the hype is overblown.
Once trading became automated, trading strategies naturally morphed
to take advantage of the available technology and higher speeds. High frequency
statistical arbitrage techniques can also mean more order cancellations, some
of which may – wittingly or unwittingly – fall into the quote stuffing
category. Those involved in intentional quote stuffing as a strategy need to be
held to task. But to demonize all strategies or call for banning them is a step
backward. What is needed is a framework by which to police them – and to
prevent them from going wrong. The technology to do this is already available.
For example, an area I’ve had a lot of experience in is the use of complex
event processing to provide a platform for high frequency, multi-venue market
surveillance. With such a system quotes can be monitored to determine how many
quotes per second there are on each ticker symbol, the ratio of quotes to
trades, when large spikes are emerging and many other interesting real-time
analytics and patterns that it’s useful to track in real-time.
But regulation of high speed trading practices has fallen short to
date. Regulators have not had the funds, the technology, the power or the
expertise to follow and control high speed trading. However, it is good to see
that progress is now being made. CFTC commissioner Bart Chilton wrote last week
in an article entitled Rein
in the cyber cowboys: “There may
be some cyber cowboys out there and they could be giving respectable traders a
bad name”. His colleague CFTC commissioner Scott O'Malia told Reuters last week
that, if traders are flooding the market with orders with the intention of
slowing others down, the regulator would consider addressing quote stuffing
under new rules in the financial regulation bill that deal with disruptive
It is possible that quote stuffing is causing more problems that just
slowing down the natural flow of trades. Trading behavior patterns suggest that
these quotes are a distraction to other traders. There are patterns evident
where the quote "stuffer" continuously traded first – possibly by
distracting others. And the disruption can cause the bid and offer to cross –
providing a nice arbitrage opportunity for those who are not distracted! All of
this needs to be looked into further. I fully support the CFTC and SEC's
efforts to get to the bottom of not just the flash crash, but HFT and
algorithmic trading practices. They are now integral in the equities and
futures markets, and increasingly so in FX, fixed income and energy. What we
need is better policing of the markets to protect the honest ranchers from the