

SEC, CFTC Report Says Algorithm Trade Set Off May 6 'Flash Crash' - jakarta
http://online.wsj.com/article/SB10001424052748703859204575525973854203534.html?mod=djemalertMARKET

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grandalf
Consider the true implications of the idea that an algorithm "set off" the
market crash:

\- Traders were happily trading along at a market price they all had
tremendous confidence in.

\- An algorithm decides to liquidate some shares, causing the market price to
dip a bit b/c of extra supply.

\- Said traders immediately lose all confidence in the market price they'd
been happily trading along at all day and start dumping their own shares.

Conclusions:

If the traders were confident in the initial market price (i.e, if they were
"right" then they should have started buying when the price started dipping.
This would have held the price up. That they didn't reveals a lot about their
own strategies.

If the fact that the order placed by the algoritm is "to blame" implies that a
human wouldn't have placed that order.

It sounds to me that the algorithm simply wanted to liquidate and wouldn't
have placed such a large market order if it were overly concerned about
getting top dollar for every share. This happens with human traders all the
time. The bigger the order the more it will move the market. There are large
trade desks that help minimize this but they take a big spread for the
service.

So ironically it was the algorithm that had a principled, deep view of the
market and the human traders who were fickle and skittish... exactly the
opposite of the typical impression of each. It's like if Kasparov were playing
against Deep Blue and Deep Blue sacrificed a pawn and Kasparov knocked over
the board.

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chipsy
Not necessarily. That hypothesis rests on the basis that the market is still
majority human-traded. Quote the article:

 _High frequency traders, devoid of any real demand from buyers of the futures
contract, began to quickly buy and resell contracts "generating a 'hot-
potato,'" the report said._

So this is algorithms-against-algorithms. I would wager that in intraday
trading, human minds play a relatively small role, because mechanical methods
break through the emotional barriers that plague pure discretionary trading.
Most good daytraders will develop a signal system to guide them, even if
individual trades use manual entries and exits.

~~~
grandalf
My understanding is that many algorithms float "test trades" to probe the
other market participants (human and machine). It would be very costly for the
algorithms to risk too much money on probing at an inaccurate price, so
chances are the "hot potato" was not very deep at all.

Nonetheless, your point stands that it could be an artifact of the traders
expecting human-like decisions to underly the phenomena they saw.

(it does seem implausible to me, but oh well)

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jakarta
PDF of the actual report:
[http://online.wsj.com/public/resources/documents/WSJ-
flashre...](http://online.wsj.com/public/resources/documents/WSJ-
flashreport10012010.pdf)

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fr0sty
The title of this post (and the WSJ article) is potentially misleading.

The 'Algorithm Trade' referenced was a Mutual Fund company executing a very
large sell order in E-mini Futures. The sell order was executed through a
trading algorithm which attempted to participate in 9% of market volume.

Many people associate 'Algorithmic Trading' with 'High-Frequency Trading' but
there is no link made by the report.

ETA: An equally correct headline could be "Large Institutional Seller set off
May 6 flash crash.

~~~
wglb
Now you have me confused.

Algorithmic Traders are quite a different species than High-Frequency Traders.

How did the article conflate these?

~~~
fr0sty
It is the popular imagination conflates them...

1\. High-Frequency trading, by definition, done by algorithms.

2\. We hear rumors or storyies of Algorithms gone wild.

3\. This report blames and 'Algorithmic Trade' as the cause.

People are tempted to 'connect-the-dots' and would likely end up with an
erroneous conclusion.

~~~
DannoHung
High-Freq is usually the label used for prop trading. Algo is usually the
label used for agency trading.

The differences between the algos used isn't really pertinent.

~~~
lrm242
The differences are huge. The motiviations behind each are entirely separate.
They are used by different people for different things.

A day trader, slogging it out in front of their computer every day is very
different from a floor broker trying to execute customer orders. That is the
fundamental difference we're talking about here. Unfortunately, any time the
markets are mentioned in connection with algorithm people instantly think
"high-frequency trading", and most often they are wrong.

