Ban 'Flash Orders'

Senator Schumer apparently believes this is an unfair practice, and I agree.

July 24 (Bloomberg) -- Senator Charles Schumer asked the U.S. Securities and Exchange Commission to ban “flash orders,” saying the transactions give high-speed traders an unfair advantage over other investors.

Nasdaq OMX Group Inc., Bats Exchange Inc. and Direct Edge Holdings Inc. hold these orders for milliseconds, giving their customers the opportunity to gauge demand before traders on other exchanges get the chance to bid, Schumer said in a letter to SEC Chairman Mary Schapiro. Brian Fallon, a spokesman at Schumer’s office, confirmed the authenticity of the letter.

“Flash orders allow certain members of these exchanges to obtain access to order flow information before that information is made available to the public,” Schumer wrote. That allows “those members to use rapid trading programs to trade ahead of those orders and profit from advanced knowledge of buying and selling activity,” he added.

The senator said that if the SEC doesn’t prohibit flash orders, he will introduce legislation that would.

This is my view:

1. Getting a look at orders before someone else does is commonly called "cheating". The National Market System (NMS) was supposed to prevent that; this was the so-called "innovation" of Nasdaq, remember? No specialists, no balancing of orders to open a stock, all done by computer. Equality of access. Up until it became profitable to make some people more equal. The intent of a public stock exchange is to insure equality of access to information so that the markets are orderly, not rigged.
2. Using flash order information (or anything else) to front-run is illegal. In all of its forms, this is an extremely serious matter and it must be stopped.
3. To the extent that these HFT systems are in fact using flash (or other) traffic to get in front of orders and advantage themselves they are dramatically increasing the violence of market moves. A stock trading at $20 that has a bid come in with a limit of $20.10 would normally fill (assuming sufficient depth) at $20; this does not materially move the market. But if a HFT system "sees" that order, steps in front of it and buys up all the shares at $20 and then re-sells them to the customer at $20.04 (one penny better than the next best offer at $20.05) it has caused the current "last" price to move where it otherwise would not. Multiply this by millions of shares an hour and the impact on price moves could be tremendous. While I understand that many people like the move of the last two weeks in the market, the fact remains that what goes up can also come down with equal violence.
4. HFT systems that front-run are able to garner risk-free profits. This is in fact the reason such a practice is banned - their "risk-free" profit is your guaranteed loss. Remember, the markets are in fact a negative-sum game (due to trading costs) - if there is a "risk-free" opportunity out there it can only exist because someone else is guaranteed a screwing.

I call upon The SEC to conduct a full and public investigation of the HFT systems in use today, along with immediately banning the "flash" traffic in accordance with Senator Schumer's request. I specifically want to know:

1. Have any of these HFT systems been using flash traffic (or any other mechanism) to "step in front" of a flashed order?
2. What part did these systems play in the October and March meltdowns, along with the ramp job of the last two weeks? Specifically, were they stepping in front of orders in these cases, thereby dramatically amplifying market moves while skimming off their pennies?

Public and fair markets demand transparency. All users must obtain access to order flow at the same time, without exception, and attempts to "step in front of the line" must be met with both civil and criminal sanction for market manipulation.

I can think of three relatively-minor changes that would leave those who are using HFT legitimately unharmed but would destroy most of the ability to cheat. These are:

1. Eliminate the 'flash order' entirely. All market participants must get order and flow information at the same time - no exceptions.
2. Force all orders (e.g. IOC, etc) to be valid for a reasonable minimum period that allows human response. 1 second would meet this criteria; it would destroy the ability of the "robots" to use abusive order patterns without preventing the legitimate use of "immediate or cancel" orders. The time selected must be greater than the average human reaction time plus round-trip network transit time within the nation; visual recognition time for young adults averages a bit over 200 milliseconds (0.2 seconds) exclusive of the response (e.g. a mouse click) and round-trip transit time on high-speed circuits cross-country (corner-to-corner) is approximately 100ms. Thus the minimum acceptable time is in the neighborhood of 500ms assuming no intervening computer computational delays (e.g. brokerage servers, etc); doubling this to provide for a margin (not all people are 20 years old, there are typically multiple computers between the exchange and end user, charting or display software requires time to post the event on the screen, etc) seems reasonable.
3. Define as "front running" by law any scheme or practice that exposes or discovers orders to any select group of players before the market as a whole, irrespective of how. The unfortunate reality is that there is no mechanism available to prevent computers from exploiting asymmetric information; ergo, you must define the provision or discovery and use of any such asymmetric information in the public markets as a criminal offense. Penalties should include treble forfeiture of all profits gained from such an abuse and a permanent ban on all access to the securities business as well as prison time.

"Arms races" are inherently negative-sum games; the only winning party is the guy who is selling the weapons. In this case the losers are the public and institutions who are attempting to invest or trade in the equities markets.

It is time to put a stop to this part of The Bezzle.

Comments

[H. T. Love:]

If anyone disagrees, I'll be left slack-jawed! ... Well, not *anybody*. The profiteers and those who "regulate" them will probably disagree.

HardToLove

Jul 27 11:42 AM

[Joseph L. S...:]

Front-running is illegal. Whether you call it front-running, flash trading, high-frequency trading, or a variation of program treading, it is illegal.

It is also unethical, unfair, and injurious to orderly markets.

Not that illegal, unethical, unfair or injurious to orderly markets has ever been more than a minor speed bump to Wall Street and their legions of overpriced lawyers.

Enforce the law. Do the right thing. Stop rigging the markets. Take back Our Street.

Jul 27 11:43 AM

[miser:]

flash trading is not front running. it is ironic that the nyse is fighting so hard against what is really a kind of electronic replication of the crowd that used to stand around the trading post on the new york floor. for all i know flash trading may be a bad thing but the front-running charge is just a smear which the smallest measure of critical thought will reveal. flash orders involve sophisticated players flashing to other sophisticated players. a flashed order is one that would lock the market if it were displayed publicly. the advantage garnered by flashers is the opportunity to receive a rebate rather than pay a fee. in such cases the advantage garnered by the recipients of flash orders is the privilege of trading WITH them, not in front of them.

Jul 27 12:07 PM

[Joseph L. S...:]

“Front running: If you trade stock or other investments because you know that an upcoming transaction by a third party is likely to affect the market price of the investment, you’re front running.” -- Dictionary of Financial Terms, Path to Investing

“Any practice of buying something the value of which is about to increase due to a future purchase by another, especially where the knowledge derives from a fiduciary relationship.” – Wiktionary

Sounds like flash trading to me.

I believe the commenter who defended the practice may have been relying upon the logic also expressed by a Wikipedia contributor: “While front-running is illegal when a broker uses private information about a client's pending order, in principle it is not illegal if it is based on public information.”

A trade that is presented, executed, and re-sold in less than a second may, “in principle” be public information, but in the real world, how “public” is that information if you have to own $20 million worth of super-computers to access it?

Jul 27 12:54 PM

[basehitz:]

Watching the 2 videos and reading the various arguments it's clear there would be a division between:

1) the few who benefit by this technique, and will fight to protect it.

2) everyone else

As Karl points out, WS has a habit of trying to figure ways to game the system. Remember, if WS hadn't figured a way to package junk mortgages and sell them as AAA, we would not have had anywhere near the mess we have now. They got massive profits. We got massive screwed. And when it blew up, we got to cover their bad trades. So they had to think of new tricks.

Thanks Karl and Zero Hedge. If the bloggers hadn't raised hell for months, probably no one else would have. BTW, CNBC is still bashing the "moronic bloggers" for interfering in their hype-fest. Way to go Charlie and Michelle Bimbette.

Jul 27 01:09 PM

[Egg:]

What about banning day trading?

That should eliminate front running if you are required to hold a position for at least one day. I would dislike this personally since I do daytrade on occasion, but I'd adjust...and it'd hurt others more than me.

Jul 27 05:31 PM

[Greg in Al:]

Egg, you don't have to ban day trading and force holdings for a day. We're talking seconds here..........

Jul 28 09:46 AM

[msgtb:]

We need a common place to write our congressmen and senators. This means that we really don't have Mr. Market and that means we don't really have a market. This has been obvious since March of this year. These people need to go to jail for what they are doing.

Good luck and good trading

Dave

Jul 28 07:09 PM