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My name is Mark B. Spiegel and I'm the Managing Member of Stanphyl Capital Management LLC. I can be reached at: mark (at) stanphylcap (dot) com. My Twitter feed is @markbspiegel
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I don't have a blog, but here's a link to a WSJ article regarding my thoughts on the "flash crash"
  • High Frequency Trading Trading: Harmful for Fundamental Investors, With ONE Exception... 8 comments
    Aug 28, 2010 11:09 AM | about stocks: PG, EXC

    As a fundamental investor (albeit, one who "trades around" his positions and uses technical analysis for entry and exit points), I thought I should learn a bit more about how I might be affected by the High Frequency Trading (HFT) about which we hear so much these days. Thus, I attended last week's IQPC Algorithmic Trading Strategies Summit in New York, and here, in layman's terms (and when it comes to HFT I'm absolutely a layman, so "corrective comments" are welcome), is a bit of what I learned...

    First, we should differentiate between high-frequency trading and algorithmic trading. What's generally referred to as algorithmic trading uses computer programs to automate what was traditionally done by traders manually. The most oft-cited example of this at the conference is when fundamental investors use software to break up large orders into a number of smaller orders so as not to excessively move the market price of a stock; meanwhile, short term traders use their own algorithmic software to try to sense when those programs are at work, and then attempt to front-run the orders. While this is extremely frustrating for long-term institutional investors (as it forces them to pay more for a stock-- or sell it more cheaply-- than they otherwise would), it's really just a modern, computerized form of "tape reading", which is pretty much what folks such as Jesse Livermore were doing 90 years ago. Fortunately, the individual investor is unlikely to be affected by this, as his or her orders are likely to be small enough that they don't show up on the "radar screens" of those short-term traders. (One important exception to this, though, would be trades executed by the portfolio managers of one's mutual or pension funds.)

    Meanwhile, all fundamental investors are likely to be negatively affected by "high frequency trading", especially a form of it called "latency arbitrage". This involves co-locating a server next to the market's centralized price-reporting data center in order to see the latest bid and offer prices a fraction of a second before most other market participants can see them. The HFTs then jump in front of those existing bids and offers with purchases or sales of their own, thereby causing the other participants to pay more for their shares (or sell them more cheaply).

    Occasionally, these HFTs may even insure that they "get the order" by providing a tiny bit of price improvement, which they more than make up for by receiving rebate payments for routing their orders to specific stock exchanges. However, this "price improvement" is generally so negligible (you may have seen this when bidding to buy a stock for, say, $3 a share, and instead having it sold to you for $2.999) that it isn't worth the frontrunning that will impact you when you're the seller whose trade doesn't go through, thereby forcing you to lower your sale price substantially more than the 1/10 of a penny you may have saved when you bought those shares. As annoying as this problem is, though, there may not be much technically that can be done about it. For instance, if co-location were banned, the HFTs would simply rent a building on private property next door to the exchange's servers, and thus they'd still be able to see the pricing information before it's seen across town (much less across the country).

    Fortunately for fundamental investors, though, in a sort of bizarre way there's one piece of very GOOD news that came from this summit: many of the experts believe that more "flash crashes" are inevitable.  Yes, you read that (seemingly insane) sentence correctly, and let me illustrate why with a personal example...

    I manage several retirement accounts for family members, and for those accounts I tend to buy primarily the kind of dividend paying, blue-chip stocks that you'd want  to see in such accounts. However, since the March 2009 lows, many of those stocks have run up to prices much higher than I'm willing to pay for them in light of my rather bearish overall perspective on the economy. Thus, since before the May 6th "flash crash" I've had a number of "good 'till canceled" orders in place for those companies at much lower than current prices, and on the day of that crash a couple of them were filled, purely because the computers went haywire. So, we picked up some "$63 pre-crash" Proctor & Gamble (NYSE:PG) at $53 (then sold it the next day at $63, where I again thought it was overvalued) and some "$42 pre-crash" Exelon (NYSE:EXC) at $38 (it bounced back later that day to $42, and we still hold it today).

    So, if you're a fundamental investor, I suggest that you enter a whole slew of bids for stocks you want to own at prices at which you want to own them (and, by the way, never enter automated sell-stop orders!), and then sit back and hope for "flash crashes" two, three, four five and six, because if they happen, you'll have a chance to make far more money from those no-common-sense computers than they're stealing from you in the meantime.

    Disclosure: Long EXC

    Stocks: PG, EXC
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  • Truthandreality
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    Comments (6) | Send Message
    Savants are constantly tweaking HFT software. Your article alerted me to something; The quant savants are paid to come up with new strategies. There must be a bunch of brains with human features who have thought of your idea already. After all, that is the only function of the savants. My guess is they've built into their algorithms something like this: a stock specific, advantageous but unlikely percentage deviation from current price. For example, if PG trades greater than, say, 8% away from it's current price, it will be advantageous to buy or short. So the HFT computer will always have orders to buy or short at prices away from the inside quote. The computers would cancel and re-enter orders as the inside quotes fluctuate.


    In essence, it is a highly likely HFT firms are ready for the next flash crash and probably hoping for it. The tricky part would be to trigger one without getting caught.


    I really hate this market. I'm gonna pop a valium, play with my puppy, then go to bed. But not before my nightly prayer; Please Lord, grant the SEC a "set of ______."
    14 Sep 2010, 09:09 PM Reply Like
  • Logical Thought
    , contributor
    Comments (5494) | Send Message
    Author’s reply » Truthandreality,


    This is an interesting (and terrific!) theory. In the midst of a new "flash crash", though, I'm not sure that the orders would go through, as in addition to my pre-existing "good 'till canceled" orders that day, I tried to enter multiple additional buy orders during the crash, and NONE of them went through. Could a computer have gotten them through? Maybe. Of course, with the new 10% trading halts, I guess none of my WAY out of the money GTC orders will execute, anyway... So maybe those damn computers really DID ruin the party for us fundamental investors, lol.
    16 Sep 2010, 06:31 PM Reply Like
  • Truthandreality
    , contributor
    Comments (6) | Send Message
    NONE went through? What is your thoughts on the efforts by Ted Kaufman and the talk by Mary Schapiro and the SEC? Do you think the SEC will actually do anything substantial? Specifically: co-location, fragmented markets (AKA Alternate Trading Systems like dark pools -- the type things which caused PG to trade simultaneously at $60 and $42) and Market Maker OBLIGATIONS to maintain their bid/offer?
    19 Sep 2010, 04:31 PM Reply Like
  • Logical Thought
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    Comments (5494) | Send Message
    Author’s reply » Yes, I was unable to enter ANY new orders during that 15 minute or so window (and I know others who had the same experience).


    I think that a lot of the most abusive practices (quote stuffing, etc.) will be banned. In fact, I think stub quotes have already been banned. The "speed edge" provided by co-location, though, is really tough to prevent. After all, even if you kick them out of the "server room", they can always rent a private building right next door, and thus still be closer to those servers than anyone else.


    Re. "market maker obligations": I don't know how you enforce that. (I'm not saying that it can't be figured out; I just don't know how.) Were you around during the crash of '87, when they all just refused to answer their phones? Well, next time that happens, they'll all pretend that their internet connections went down!
    19 Sep 2010, 07:20 PM Reply Like
  • Truthandreality
    , contributor
    Comments (6) | Send Message
    Yes, clearly defined market maker obligations is the major issue. Ultimately, this is why we had the "Flash Crash." And I also agree, we will have more flash crashes until the SEC steps in and does their job of "maintaining fair and orderly markets." Market maker obligation; this is a difficult task which the SEC must focus on. It's a balancing act. A market maker must have incentives to honor and maintain quoted bids and offers. For the SEC to find firms willing to fill orders they would rather not fill, there must be incentives. Currently however, the larger HFT firms have an "edge;" co-location, sub-penny pricing, mini Markets such as dark pools, flash orders and so on. But at the same time, these same firms have no obligations. It's the "cake and eat it too" scenario.


    As to co-location. I have some ideas which address this market killing, untenable, unfair practice. I need to examine whether my ideas are practical or not. But I do feel co-location can and must be addressed.
    22 Sep 2010, 05:54 PM Reply Like
  • Logical Thought
    , contributor
    Comments (5494) | Send Message
    Author’s reply » >> I have some ideas which address this market killing, untenable, unfair practice [of co-location].<<


    As I said earlier, the HFT computers could just move to some private property next door, and still have an advantage. There's probably a way to negate this electronically, whereby the system builds in a delay (or not) based upon the IP address of the information recipient, so there's no geographical advantage for anyone. However, designing such a system (or even determining if it would work) is way out of my realm of competence and, of course, there's probably some kind of "IP-spoofing" countermeasure that the traders could create, too.
    23 Sep 2010, 07:11 AM Reply Like
  • Truthandreality
    , contributor
    Comments (6) | Send Message
    Exactly. You and I seem to agree: if there is some way to remove the co-location advantage, the SEC should remove it. I know of a trading house which has over 500 day-traders, trading US stocks from China. Yes, day-traders from China! -Well, anyway, I was surprised.- The CEO told me the Chinese day-traders trade much differently than US day-traders because they are well aware of the latency issue. Chinese day-traders are 11,000 miles away. They are stuck with latency issues.


    But it seems wildly unfair that a trader 10 miles from the Exchanges' nerve centers should have latency inequity as well. A trade should be executed based upon price and time. If I place an order a few milliseconds before a HFT firm, at the same price, I should be filled first. The SEC agrees with this. In fact, the SEC formally has accepted the responsibility to police the markets for price/time fairness.


    Whether co-location is a unfortunate reality without a solution is debatable, but HFT firms are paying millions to co-locate. The SEC has accepted and allowed a huge barrier to entry (paid-for co-location) to flourish. At the very least, the SEC should formally frown on the practice and make it more difficult for the co-locators.


    I like what the "new SEC" is saying. They have a good deal of catching up to do. Years of neglect (eight to be precise) by the "old SEC" requires patience from market participants. There is a lot to undo.


    On a side-note, I'm new to Seeking Alpha. I'm "following" you. The only person following me thus far is myself. Any chance you could kinda just click that Follow button to reciprocate.
    23 Sep 2010, 04:20 PM Reply Like
  • Logical Thought
    , contributor
    Comments (5494) | Send Message
    Author’s reply » lol... Sure, I will follow you.
    23 Sep 2010, 05:50 PM Reply Like
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