Tagged: High-speed Trading

Low Spreads

What keeps stocks going is low volatility.

By seeking only to earn the spread on each transaction and not bet on the direction of markets, you can make money close to 50 percent of the time.

This one sentence from a profile of high-speed firm Virtu by Bloomberg’s Matt Leising to me summarizes the US stock market and its durability.

Computers focus on the difference in cost to buy or sell a very small thing – a handful of shares. They don’t weigh the viability of the entity reflected in the shares or any measure humans use to determine fair value. Thus, what difference does it make whether so-called fundamentals support the price? We’re asking the wrong question.

In the world apart from stocks, European growth is abysmal. Emerging economies are sputtering. The US economy is growing about 1% and juxtaposed with a long slide in productivity, falling revenues in the S&P 500 and five quarters of earnings contraction.

Since 1954, according to Financial Advisor magazine, twelve earnings recessions have met ten actual ones, and stocks have always fallen, the least, 7%, in 1967, and the most, 57%, in 2008-9.  In this one, the stocks of businesses making what drives consumption and employing the consumers and earning the profits that fund the investments core to economic growth are thus far up.

Why is it different this time? One could say “central banks.” Yes, today’s foremost Enron-like off-balance-sheet entities, central banks, have conspired to force people to overpay for most things in the name of helping us all. But they’re a supporting cast.

The main actors are nearer. This era in stocks, thanks to regulations implemented in 2007, is the first to depend almost entirely in the very short-term for prices from computerized systems tracking spreads in prices.

What motivates machines are small spreads. Virtu, with but one losing day from 2009-2014 often pockets peanuts. In one instance from the story, Virtu traded gold ETFs and futures 26 times and earned $36.

But Virtu trades securities from Africa to London sometimes five million times in a day. Its software sits in more financial markets (Bloomberg says 230 globally) than its employee headcount (148 as of Dec 2015).

I hear good things about Virtu from people I respect.  The point here isn’t to judge Virtu or fast trading but to explain why the market cannot, for now, be measured fundamentally. Last week, silver ETFs were top performers and gold and steel ETFs lagged most. It was excruciating hearing analysts trying to explain it rationally.

How stocks behave fits the low-spread phenomenon. The market is a daily life cycle from highs to lows and recoveries and vice versa. It’s a product of tiny spreads and small changes. Narrow gaps mean limited risk as automated trading systems search for ways to set prices between buyers and sellers.

Of course there must be buyers and sellers. The epic symbiosis of our era is high-speed trading and Asset Allocation. This is investing via apportionment such as indexes, exchange-traded funds and quantitative models. This money doesn’t assess prices but follows the map, bread crumbs dropped in enticing meager increments by machines.

Watching the steady march, stock-pickers then reach a nexus of fear and greed, taking the baton and carrying on even as the most ebullient bulls put pensive scratching fingers to noggins. Yesterday we tallied new Rational Prices indicating buying by Active money in nearly 20% of our client base. Fund managers are paid to invest and do, despite wariness.

Low volatility means not the absence of risk but that machines are in charge. Shares falter only when spreads become unmanageable as on May 6, 2010, August 24, 2015, and other manic gap episodes. Big gaps form on distortion among traded asset classes such as stocks, bonds, currencies, commodities and derivatives.

What causes unexpected distortions? If we knew, I’d be writing to you from Monaco. Here outside Austin as we visit family this week, I can only theorize from a decade modeling market behavior.  Distortions today form when the value assigned to any asset class in the future is wrong.  Derivatives are the weak link.

Options expirations for August start tomorrow. Sentiment is positive and stocks are rising, which means they’ll probably fall afterward. But there’s little risk. The machines are in charge. Volatility is low.

Now if you’ll excuse me, I want to get off the bridge over these placid waters.

Split Millisecond

You’ve heard the phrase split-second decision?

For high-speed traders that would be akin to the plod of a government bureaucracy or the slow creep of a geological era.

Half a second (splitting it) is 500 milliseconds. One millisecond equals a thousand microseconds. One microsecond is a thousand nanoseconds, and a microsecond is to one full second in ratio about what one second is to 11.6 days.  Fortunately we’re not yet into zeptoseconds and yoctoseconds.

IEX, the upstart protagonist in Michael Lewis’s wildly popular Flash Boys, has now filed to become a listing exchange with the NYSE and the Nasdaq.  Smart folks, they looked at the screaming pace of the stock market and rather than targeting the yoctosecond (one trillionth of a trillionth of a second), said: “What if we slowed this chaos down?”

It was a winning idea, and IEX soared up the ranks of trading platforms.  Oh, but ye hath seen no fire and brimstone like that now breathed from high-speed traders and legacy exchanges.  You’d have thought IEX was proposing immolating them all on a pyre.

Which brings us back to one millisecond.  IEX devised a speed bump of 350 microseconds – less than half a millisecond – to slow access to its market so fast traders could not race ahead and execute or cancel trades at other markets where prices may be microseconds different than IEX’s.

Speed matters because Regulation National Market System (Reg NMS) which ten years ago fostered the current stock market of interconnected data nodes and blazing speed said all orders to buy or sell that are seeking to fill must be automated and immediate.

Of course, nobody defined “immediate.”  Using only common sense you can understand what unfolded.  If the “stock market” isn’t a single destination but many bound together by the laws of physics and technology, some humans are going to go, “What if we used computers to buy low over there and sell high over here really fast?”

Now add this fact to the mix. Reg NMS divided common data revenues according to how often an exchange has the best available price. And rules require brokers to buy other data from the exchanges to ensure that they know the best prices.  Plus, Reg NMS capped what exchanges could charge for trades at $0.30 per hundred shares.

Left to chance, how could an exchange know if it would earn data revenues or develop valuable data to sell? Well, the law didn’t prohibit incentives.

Voila! Exchanges came up with the same idea retailers have been using for no doubt thousands of years going back to cuneiform:  Offer a coupon.  Exchanges started paying traders to set the best price in the market.  The more often you could do that, the more the exchange would pay.

Now those “rebates” are routinely more than the capped fee of $0.30 per hundred shares, and now arguably most prices are set by proprietary (having no customers) traders whose technology platforms trade thousands of securities over multiple asset classes simultaneously in fractions of seconds to profit from tiny arbitrage spreads and rebates.  Symbiosis between high-speed firms and exchanges helps the latter generate billions of dollars of revenue from data and technology services around this model.

Enter the SEC in March this year.  The Commission said in effect, “We think one millisecond is immediate.” Implication: IEX’s architecture is fine.

But it’s more than that. Legacy exchanges and high-speed traders reacted with horror and outrage. Billions of dollars have been spent devising systems that maximize speed, prices and data revenues.  The market now depends for best prices on a system of incentives and arbitrage trades clustered around the capacity to do things in LESS than a millisecond. The evidence overwhelms that structure favors speed.

Is a millisecond vital to capital formation? I’ve been running this business for eleven years and it’s taken enormous effort and dedication to build value. I would never let arbitragers with no ownership interest price in fractions of seconds these accumulated years of time and investment.

So why are you, public companies? Food for thought. Now if a millisecond is immediate, we may slam into the reality of our dependence on arbitrage.  But really?  A millisecond?


We marked May’s end aboard a boat on the trade winds from Norman to Anegada in the archipelago of the British Virgin Islands. It’s an indisputable jewel of that empire upon which the sun once never set.

Now, back to reality!

“Arnuk and Saluzzi, the principals of Themis Trading, have done more than anyone to explain and publicize the predation in the new stock market.”

So writes Michael Lewis in his No. 1 New York Times bestseller Flash Boys, which rocked the US stock-market community. If you’re coming to NIRI National next week in Las Vegas, put this on your calendar:

I’m moderating a fireside chat with Joe Saluzzi (regular CNBC and Bloomberg TV guest, two 60 Minutes appearances about high-frequency trading) on Tuesday June 10 at 4:10p in Bellagio 2. Click here for details. Expect insight and entertainment – and bring hard questions!

Speaking of markets, did you see that Credit Suisse and Goldman Sachs released details about their dark pools? These are members-only trading venues regulated as broker-dealer Alternative Trading Systems under what’s called Reg ATS.

Credit Suisse’s Crossfinder is reputedly the world’s largest such market, which is in part due to the volume of orders that other brokers are routing to Credit Suisse. We monitor routing practices. It’s apparent to us that Credit Suisse leads in routing market-share.

Now, why do they lead? And why should you care, there in the IR chair? Because how the market for your shares functions is in the IR wheelhouse. Right? You know how your company sells products and services. How about the way your shares are bought and sold?

After all, the goal of IR boiled down to quintessence is to foster fair value in your shares and a well-informed marketplace. How do you know when that’s true?

One might say “when my shares reflect a certain multiple of the discounted present value of future cash flows.” But that measure is only true for investors measuring cash-flows. Eighty-five percent of your volume comes from forces motivated by something else.

You can’t control these but you can influence them, and measure them, and differentiate between when your active investors are setting price, and when something else is. To the degree that the prices of one are similar to the other, your market is fairly valued. It’s that simple, but you have to establish a way to measure it (we have).

Which leads back to Credit Suisse Crossfinder. In its Form ATS, the broker says it segments participants in its market into four groups.

Son of a gun. We segment the entire market into four groups, both in individual shares, and broadly, so we can see variances in these groups comparatively and by duration.

Credit Suisse calls the four groups Natural, Plus, Max and Opportunistic. The broker creates what it calls an “objective formula” predicated on a “variety of metrics” to “capture the trading behavior” of these clients.

Well. That’s exactly what we do. We think Credit Suisse is successful because it observes its clients’ behaviors and clusters similarities to improve outcomes for them. Logical stuff. I’m sure they know which behavior is dominating at any given time.

So do we, in the way we measure four behaviors ranging from natural to opportunistic. Now, why does this matter to IROs? For the same reasons. To improve behavioral outcomes. And because it’s how the market works. It’s how institutions are behaving.

I’ll probably fall short of instilling profundity, but this is on a magnitude of realizing that the earth you thought was flat is in fact round. It changes everything.

The holy grail of market intelligence isn’t knowing if Fidelity bought. It’s understanding whether the behavior of your dollar-flow is natural or opportunistic. That, my friends, is where the meaning lies.

Well, The Meaning may also be just off the coast of Virgin Gorda. Meanwhile, see you next week (booth 615) in Las Vegas!

Fires, Crashes and Kill Switches

Suppose the engine of your vehicle was on fire.

The logical response would be to shut it off. But what if you were traveling at highway speed and killing the fuel supply meant you had no power breaks or steering? What if your vehicle was a jet fighter?

There are ramifications.

Last Thursday and Friday stocks plunged. Monday and Tuesday this week, shares soared. I doubt most of us think that people were selling in a stampede last week and then woke up Monday and went, “Shazzam! What have we done? We should be buying!”

Context matters.

This week offers an event in similar rarified air as blood moons in the northern hemisphere. Good Friday closes markets to end the week. Between are the usual three sets of expirations: volatility derivatives, index futures, and the remaining host of options and futures set for monthly expiry (with earnings now too – another reminder for you learned IROs to avoid that mash-up if at all possible). (more…)

The Recovery

It’s all in the recovery.

That’s the philosophy put forth by a friend of mine for dealing with unpleasant facts.

I think the chief reason for the recent swoon in stocks was not anemia in the job market but a sort of investor outrage. You can’t troll a trading periodical or blog or forum without wading through rants on why Michael Lewis, author of the bombshell book Flash Boys on high-speed trading, is either guilty of torpid whimsy (a clever phrase I admit to swiping from a Wall Street Journal opinion by the Hudson Institute’s Christopher DeMuth) or the market’s messiah.

What happens next? Shares of online brokerages including TD Ameritrade, E*Trade and Schwab have suffered on apparent fear that the widespread practice at these firms of selling their orders to fast intermediaries may come under regulatory scrutiny.

What about Vanguard, Blackrock and other massive passive investors? Asset managers favor a structure built around high-speed intermediation because it transforms relentless ebbs and flows of money in retirement accounts from an investing liability to a liquidity asset. Asset management is about generating yield. Liquidity is fungible today, and it’s not just Schwab selling orders to UBS, Scottrade marketing flow to KCG and Citi or E*Trade routing 70% of its brokerage to Susquehanna.

It would require more than a literary suspension of disbelief to suppose that while retail brokers are trading orders for dollars, big asset managers are folding proverbial hands in ecclesiastical innocence. The 40% of equity volume today that’s short, or borrowed, owes much to the alacrity of Vanguard and Blackrock. The US equity market is as dependent on borrowing and intermediation as the global financial system is on the Fed’s $4 trillion balance sheet.

Hoary heads of market structure may recall that we wrote years ago about a firm that exploded onto our data radar in 2007 called “Octeg.” It was trading ten times more than the biggest banks. Tracing addresses in filings, we found Octeg based in the same office as the Global Electronic Trading Co., or GETCO. Octeg. Get it? (more…)

Flash Boys

I don’t skateboard. But the title of Michael Lewis’s new book on high-speed trading, Flash Boys, made me think Lewis could’ve called it DC-town & Flash Boys.

Legendary skateboarder Stacy Peralta directed the 2001 documentary Dogtown & Z-boys chronicling the meteoric rise of a craze involving slapping wheels on little boards and engaging in aerobatic feats using public infrastructure such as steps and handrails. From Dogtown, slang for south Santa Monica near Venice Beach, Peralta’s Sean-Penn-narrated film tracked the groundbreaking (and wrist-breaking) 1978 exploits of the Zephyr skateboarding team, thus the “Z-boys.”

Skateboarding has got nothing to do with trading, save that both are frantic activities with dubious social benefit. We’ve been declaiming on these pages for more than a half-decade how fast intermediaries are stock-market cholesterol. So, more attention is great if the examiner’s light shines in the right place.

If you missed it, literary gadfly Lewis, whose works as the Oscar Wilde of nonfictional exposé include Moneyball (loved the movie), Blindside, Liar’s Poker and the Big Short, last week told 60 Minutes the US stock market is rigged.

The high-frequency trading crowd was caught flat-footed. But yesterday Brad Katsuyama from IEX, a dark pool for long investors that rose out of RBC, dusted it up on CNBC with Bill O’Brien from BATS/Direct Edge, an exchange catering to fast orders.

Which brings us to why Lewis might’ve called his book DC-town & Flash Boys. The exploitation of speedy small orders goes back to 1988. In the wake of the 1987 crash, volumes dropped because people feared markets. The NASD (FINRA today) created the Small Order Execution System (SOES – pronounced “soze”) both to give small investors a chance to trade 100 shares electronically, and to stimulate volume. Banditry blossomed. Professionals with computers began trading in wee increments. Volume returned. The little guy? Hm.

Regulators have always wanted to give the little guy opportunity to execute orders like the big guys. It’s admirable. It’s also impossible. Purchasing power is king. Attempt to make $1 and $1,000 equal in how trades execute, and what will happen is the big guys will shift to doing things $1 at a time. The little guy will still lose out but now your market is mayhem confusing busy with productive.

These benighted gaffes seem eerily to originate in Washington DC. Michael Lewis says big banks, high-speed traders and exchanges have rigged markets. We agree these three set prices for everybody. But they’re following the rules. (more…)