
Mysterious Algorithm Was 4% of Trading Activity Last Week - mikecane
http://www.cnbc.com/id/49333454
======
confluence
What people don't seem to get about HFTs is that retail investors cannot and
should not attempt to compete with them or trade actively at all - HFT or prop
trading is a big no-no for the unsophisticated.

Historically buying into an index fund during a crisis is a perfectly
reasonable way to achieve relatively easy alpha above the mutual fund/bond
rates (~12% per year).

This type of investing (aka diversified value) is completely separate from
HFT. As far as many retail investors should be concerned HFTs can duke it all
out between themselves as much as they want - it really doesn't matter and is
irrelevant to your long term investment decision.

Indeed HFTs provide the benefit that during times of crisis they provide
plenty of buy side liquidity for you to get in at a lower spread and a lower
spot price relatively easily.

~~~
dfc
Are you saying that HFTs have no impact on Alice and Bob regardless of how
prudent they are about investing? In addition to ETFs Alice and Bob also have
market exposure through a company 401k. Are the 401k managers and ETF managers
immune to the effects of the HFTs?

On the page[1] first documenting this algo NANEX says the following:

 _"We believe that this algo will continue to grow and if left unchecked,
could very well contribute to the next flash crash because it removes precious
network capacity and provides zero economic value such as price discovery."_

Do you disagree?

[1] <http://www.nanex.net/aqck2/3610.html>

~~~
confluence
It has no effect on Alice and Bob if they don't sell. It is favourable to them
if they buy.

The stock price is just the opinion of 0.2% of people at any one time - and
hence means essentially nothing to an investor. Does the spot price
opinion/first impression of a person matter - or does the long term attributes
of their character matter? Just because there are more opinions - being given
at a faster rate - doesn't mean that a) they're right or b) they should be
acted upon as fact and c) that they shouldn't be exploited for those of a more
stable nature.

For example: I bought a huge amount of TSLA stock when it fell 12% in one day
a week or so ago for no particular reason. I subsequently realised a 6% gain.
I'm happy - thank you HFTs and short term traders - your vol makes my alpha.

~~~
knieveltech
What you are describing is a method of turning a profit on automated wealth
destruction, or am I misunderstanding something?

~~~
Variance
There's as much wealth created when the price rises again as there is
destroyed when the price first erroneously falls, all other things equal.
What's really being described is turning a profit on prices that are, for
whatever reason, set too low and return to previous levels soon after.

~~~
ScottBurson
Of course, the poor sods who had their stops blown don't get their money back
-- the recreated wealth winds up in someone else's pocket.

But then, blowing out people's stops so you can buy up the stock cheaper is a
time-honored trick.

~~~
confluence
Stop losses are stupid - period.

If you're investing for long term - you shouldn't be investing in things that
require stop losses.

If you're investing on margin - take a good hard look at yourself before you
blow up.

If you're trading options - unless you're pushing liquidity - watch yourself
before you blow up.

Sell side liquidity is there - until it ain't. Stop losses don't protect you.

~~~
runako
>> If you're investing for long term - you shouldn't be investing in things
that require stop losses.

Except that in the long term good companies sometimes go bad quite suddenly.
Frequently, the harbinger (e.g. CFO suddenly quits) will erase a lot of wealth
quite rapidly. Stops are a good way to not have your portfolio blow up while
not also having to obsessively follow the news.

~~~
stouset
As an individual investor, you're not going to beat the automated algorithms
on breaking news anyway. Trading individual stocks is a fool's game. Buy and
hold index funds.

~~~
runako
Just to be clear, I wouldn't counsel racing algorithms (this should be
obvious). But you want to be able to exit somewhat rapidly in case of
catastrophe at a portfolio company. A stop can turn a big loss into a smaller
loss.

>> Buy and hold index funds.

To each his own, but this strategy has been pretty easy to beat over the last
20 years (even easier over the last 10), for those willing to study companies
at all.

------
podperson
For many years George Soros has been suggesting that a tiny tax on
transactions would eliminate a huge amount of high frequency bullshit (he was
suggesting it for currency markets, but the same applies here). I think he
proposed that the revenue generated could fund the UN... It's about the same
Bill Gates's suggestion of charging a penny to send an email -- no impact on
legitimate use and a serious impediment to spammers.

~~~
xenophanes
How does charging me somewhere vaguely in the ballpark of $36.50 per year
qualify as "no impact"?

And I'm just an individual. What about when I send to an email list and it
goes to 100 people? Should Google Groups pay a dollar to send out those 100
emails? What about MailChimp, do they have pay $200 when they send out a
newsletter to 20,000 people?

I'm also concerned about how this money will be collected and how, from a
technical perspective, all emails will be monitored. Every SMTP server will
now have to be registered with the central oversight organization? VPNs and
rogue email installations will be the enemy or blocked from communicating with
anyone "on the grid"?

~~~
Evbn
You may not be aware now, but postal mail is on fact charged per unit, no
central registry needed, just a stamp.

~~~
xenophanes
I don't think you understand how email works.

Or the post office for that matter. There's actually one single organization
that all those stamped envelopes get sent through, it's not decentralized.

------
ahi
"Translation: the ultimate goal of many of these programs is to gum up the
system so it slows down the quote feed to others and allows the computer
traders (with their co-located servers at the exchanges) to gain a money-
making arbitrage opportunity." I thought the justification for HFT was
liquidity. The market is clearly broken.

~~~
jacobwil
I believe that they were talking specifically about the programs which create
orders which are never fulfulled. That way their programs creating real trades
have an advantage (since they are running on servers located closer to the
exchanges).

~~~
skorgu
Bear in mind the exchanges aren't stupid, Nasdaq at least has instituted a
penalty system for sending a bajillion orders and not actually trading [0].
One may certainly quibble with the exact rates and penalties but this is a
thing that exists.

[0] <http://www.nasdaqtrader.com/TraderNews.aspx?id=ETA2012-13>

~~~
greenyoda
It makes a lot of sense to penalize that kind of behavior. Deliberately
slowing down the quote feed or cancelling all your trades seems to be intended
as a denial of service attack on your competitors.

------
lojack
So, the video made it sound like someone was holding a large amount of stocks
and very quickly sold all of them (like the flash crash). It didn't lead me to
believe that they were placing orders and pulling them before they could be
executed. Was this type of order discovered after the video recording, or am I
misunderstanding what they said?

Also, in the video they say:

"What you're saying is the individual investor has no shot. Mary and Joe
sitting out there have no quants on their staff"

My assumption was always that the average trader holds their shares over a
longer period of time, and thus aren't really affected by these HFT
algorithms. Is that assumption incorrect?

~~~
tptacek
No, it is not incorrect. The impact of HFT on buy & hold investors is probably
a wash. Automated trading has cut the bid/ask spread but may contribute to
volatility (it is tougher to say than it seems).

Either way, Mary and Joe were never competing with market makers and active
trading strategies, and still aren't now.

~~~
marshallp
That's not entirely true. I'm an amateur and I want to invest actively using
statistics. But getting tick data (covering years/decades) is costly and
dealing with it as well. I could handle it if it were daily (if all trades
were limited to 9am auction every day. This would also allow room for much
more extensive modeling of other data sources and longer term predictions).

~~~
vecter
That's not a very convincing argument. I'd like to participate in F1 racing,
but the research and engineering costs are too high for me as an individual to
partake in. If they limited racing to only 4-cylinder non-modded Hondas, it
would allow me to compete in their game.

~~~
marshallp
F1 racing is a game. You're then equating stock trading with a game (a casino)
when it should be serving everyone in society.

Closing off a large number of people because they lack "sophistication" is
called facism. We should be striving for small c capitalism.

~~~
vecter
That's a false premise. The "purpose" of capital markets isn't to "serve
society" any more so than the "purpose" of restaurants is to "serve food".
Restaurants (and any other businesses for that matter) exist to generate
profits. They merely satisfy that goal by serving food, but it could be done a
million other ways.

The stock market exists not because of some idealized goal of serving society,
but because companies want to sell partial ownership and transfer risk from
themselves to the public in exchange for potential future returns on that
investment. Anyone member of the public who purchases stock in a company
should understand that agreement. It also has secondary benefits like
providing liquidity for employees, etc., but the New York Stock Exchange
wasn't founded with that purpose in mind. In other words, the stock market
doesn't _owe_ you anything.

That point aside, could you clarify how HFT hurts you? If your goal is to use
stock markets as an investment vehicle, then your time horizon should be on
the order of months and years, not seconds. If that's the case, then HFT has
no impact on you whatsoever. If you _do_ want to play in the second time
range, then my analogy with F1 racing is perfectly applicable and there's no
justification for your complaint.

~~~
marshallp
That's not false - capitalism is justified by it's proponents by it's ability
to serve the public better than socialism (the majority of the public wants
more socialism - entitlements/public services etc). Some aspects of capitalism
(copyrights, patents, HFT, pollution) are not serving the public and there are
valid arguments from the opposing side.

My goal is to trade daily/weekly (in addition to monthly/yearly). I don't want
to seconds/minutes/hours (and so can't many others - so the "competitiveness"
of markets is actually reduced).

Ultimately, stock markets exist to raise funds for projects (exits for
entrepreneurs, financing projects in large corps) - they occur on the daily-
years timeframe, not seconds/minutes/hours.

~~~
Evbn
You say HFT hurts the public, but you only show evidence that it hurts LFT.
Why do we care about kow frewuency traders, aka parasites who profit from
statistical patterns and not by contributing any value?

~~~
marshallp
By that reasoning, HFT are parasites too. More generally, the stock market
exists to allocate resources. Is society already so efficient that millisecond
allocation needs to occur?

------
davidtyleryork
This makes Mark Cuban's article on High Frequency Trading (HFT) even more
relevant than it was before (link: [http://blogmaverick.com/2012/09/21/what-
business-is-wall-str...](http://blogmaverick.com/2012/09/21/what-business-is-
wall-street-in-3/)). WHY is it not regulated or at the very least taxed, when
it creates such outsized risk for the public and doesn't accomplish anything
for the market besides increased volatility

~~~
twoodfin
If you're so worried about it, just don't invest in markets that allow it. The
"public" is only capable of risking their own money.

~~~
Steko
This sounds like "don't go outside if you're worried about being mugged".
Sorry, no we almost all pay taxes used for bailouts and have our retirements
invested there by our employers. We get to criticize and advocate for change.

~~~
Evbn
Please look at who got hailed out and what they were doing.

Issuing a sham mortgage is not a high frequency trade.

------
dfc
The NANEX research page[1] has a lot more information about the different MOs
that they spot. It looks like NANEX first spotted it on October 1st:

 _"On October 1, 2012, we detected a new form of quote stuffing that tries to
hide under the radar. It involves hundreds of stocks and millions of bogus
quotes during the trading day. The algo that generates them is very careful to
spread out the stocks targeted and limits each test to a blast of exactly 200
quotes in 25 milliseconds or less. The quotes all come from Nasdaq, and
sometimes affect the Best Bid or Offer: the only change appears to be a
fluttering of the bid or offer size."_ [2]

Doing my best tptacek impression "the nut graf is":

 _"We believe that this algo will continue to grow and if left unchecked,
could very well contribute to the next flash crash because it removes precious
network capacity and provides zero economic value such as price discovery."_

They posted an update on the 5th with a neat visualization of the trading
activity[3]. If you just want to see a neat animated gif the direct link is:

<http://www.nxcoreapi.com/aqck2/Algo200.gif>

They have a list of the activity from October 1st[4], but it is not clear to
me what the second and third fields are:

Example:

    
    
        09:01:03|P|9|UMDD
        09:01:03|P|6|MVV
        09:01:03|P|6|MIDU
        09:01:03|P|4|IVOO
        09:26:20|P|9|UMDD
        09:28:44|P|7|SGOL
    

The second and third fields have the following possible values:

    
    
        13 4 N P Q
        0 1 2 3 4 5 6 7 8 9 a A b B C D E F
    

I was looking at the nxcore api docs [5] and I could not tell what these
fields could be. The field values do not seem to match up to the listed values
for exchanges or order types.

[1] <http://www.nanex.net/aqck/aqckIndex.html>

[2] New Quote Stuffing Algo <http://www.nanex.net/aqck2/3610.html>

[3] Quote Spammer Spotted <http://www.nanex.net/aqck2/3614.html>

[4] <http://www.nanex.net/aqck2/3610%5C20121001.200.txt>

[5] <http://www.nanex.net/apidocs.html>

EDIT:

I am delighted and rather surprised to say that someone from NANEX responded
to my inquiry about the second and third fields.

 _"P = ARCA (we've since determined that the algo only ran on NYSE and Nasdaq
listed issues)

N = NYSE

Q = Nasdaq

The 3rd column is the SIP multicast line that would carry the quote. For
Nasdaq listed, those are carried on UQDF which uses 6 lines and we label as A,
B, C, D, E, F. For NYSE/ARCA listed those are carried on CQS which uses 12
lines, we label as 1-9,a,b."_

~~~
mcphilip
Excellent write up, I was hoping Nanex had some info on this. Tangentially
related, The Rise of the HFT Machines is another great Nanex article that
argues how it's not so much HF trading that threatens market stability, it's
the HF quoting[1].

There are some great charts illustrating how every time exchanges increase
quote processing capacity the HF algos gobble up the new bandwidth, but
ultimately the number of executed trades has remained relatively consistent
over the past five years.

[1]<http://www.nanex.net/aqck/2804.HTML>

------
mey
How does the exchange charge for access? Per trade, per bandwidth, per colo
distance?

It would be simple for the exchanges to reign in trading by adjusting their
pricing model. Make it more expensive to make each type of request. Adding a
few cents to the request would squash HFT while not drastically effecting
other trading systems/people.

~~~
cube13
All of the above, actually.

The exchanges have a per-trade charge, and for the data, they charge fees on a
per data stream basis, and charge for colocation.

And they already do make each tier more expensive than the previous.

~~~
skorgu
Here's Nasdaq's price list:
<http://www.nasdaqtrader.com/trader.aspx?id=pricelisttrading2>

~~~
mileswu
>Each 56kb line with single hub and router (for remote disaster recovery sites
only)

Mm good old days of dialup. All yours for $900/month.

------
yk
Translation of "Translation: the ultimate goal of many of these programs is to
gum up the system so it slows down the quote feed to others and allows the
computer traders (with their co-located servers at the exchanges) to gain a
money-making arbitrage opportunity." Annomyous is (D)Dosing the market. :D

------
tantalor
Misleading headline; trades are not the same as quotes.

------
delinka
"Mysterious algorithm..."

I suppose that's technically correct-- we don't know how the algorithm works.
But they make it sound like they have no idea to whom the algorithm belongs.
If your logging can't get you this information (the bot's owner), I have no
hope for the security of the exchanges.

If this kind of thing is a problem, then read your logs, visit the 'offending'
party, and Do Something About It.

~~~
dfc
Read your logs? The people that identified the algo are just looking at quotes
coming in from different exchanges. What logs do you think they can look at?

~~~
Jupe
So, requests come into the trading system and there's no tracability? No
credentials? No security? I'm not very religious, but heaven help us if this
is the state of the Wall Street automation!

~~~
yummyfajitas
The SEC and individual exchanges have access to the full non-anonymized feed.
Other market participants, such as nanex, only get the anonymized feed.

------
johnmacintyre
"abruptly ended at about 10:30 a.m. Friday" ... am I the only one who sees
this as a probable programming bug? Mysterious algorithm? I suspect

if(condition = true){...} // notice the single '='

:-D

------
mratzloff
Someone help me out. Why can't they just throttle connections?

------
marshallp
Another reason to limit trading to daily or weekly or montly. The trading arms
race is focusing on speed when it should be focusing on predicting longer term
outcomes. The easiest way to do so would be to limit all trades to once per
day in an auction system. Then traders would pour their resources into
building sophisticated systems that make long range predictions and so also
identify new innovations/companies that should exist in the market. This is in
literally almost everyone's best interest - investors, public corp's,
governments, consumer - only a small group of high-speed traders would
disagree. Why this hasn't occurred yet is mind-boggling.

~~~
ArchD
Suppose the NYSE has a new rule where trades only happen once a day, in a
morning auction. Imagine that you just bought some stock at the auction in a
certain company. Later on in the day, the company announces some catastrophic
news, but you have to hold on to your stocks until the next day's auction,
only to suffer great loss when you sell.

Meanwhile, on a options exchange, a different exchange, where trading happens
throughout the day because there is no such regulation, other investors in the
same stock get to hedge their position by selling call options. They get to
act ahead of you because their exchange has no such regulation. Unfortunately
for whatever reason, you have no access to this venue. Should regulators
regulate these exchanges as well? If they don't, someone will complain that
it's unfair to people who have no access to such exotic venues. So, let's say
they regulate all exchanges in the country.

Then, people who really want to trade in the middle of the day have to do it
the 'good' old-fashion way, away from the exchange, making phone calls to each
other, through brokers, where there's less transparency and more chance for
corruption and unfair deals because the fair price of an instrument is unclear
due to the absence of exchange activity. This would be a step backward.

Additionally, in terms of raising and reallocating capital, companies whose
stocks are thus regulated will be at a disadvantage relative to their
international counterparts whose stocks are more liquid in the absence of
similar regulation, as capital tends to flow where trading is more convenient.
So, this effect would impact the country's competitiveness as well.

~~~
vl
Bonkers, currently exchanges are only open from 9:30am to 4pm EST Mon-Fri. So
your "doomsday" argument is equally applicable - most companies make
announcements outside trading hours and most unhedged investor loose money
once marker opens if announcement is negative.

~~~
ArchD
Typical US equity trading hours roughly coincide with normal working hours.
Not many people would want to stay around too late. Even if they did, the
liquidity they need may not be there because most people have stopped working
for the day.

