$45 Billion in Less Than 1 Second

Today we should all be cheering.  The Dow closed up 121 points — a new (yawn) record high.  But all is not well in stock-land.

Pity poor Anadarko Petroleum Corporation (APC).

At 3:59:59:10 p.m. this afternoon, APC was worth $45 billion.  50 milliseconds later, the company was worthless.  As evidence, I present the following chart courtesy of Bloomberg:

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The area circled in red shows the value of APC dropping from over $90/share to $0/share in 50 milliseconds.

Neat trick.

We may laud the great bull market of 2013, cheer the daily all-time highs, and toast the 120% gains achieved since the market’s nadir in 2009.  But when you sweep away all the celebratory confetti, you see a system that is extremely vulnerable.  This flash crash was not in some $2 stock with 32, 000 shares trading each day.  It was Anadarko-freaking-Petroleum — a stock with an average daily volume of nearly 4 million shares.

But, no worries.  I was just notified by DECS that all trades below $87.56 “will be busted.  This decision cannot be appealed.”

Hey!  Why fix the system when you can simply bust trades that occur because your system is a joke.

Speaking of jokes…  Two HFT algorithms walk into a bar…

-LL

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The Market’s Amazing Technicolor Dreamchart

With High Frequency Trading accidents occurring at an accelerating rate (Flash Crash, BATS IPO, Facebook IPO, Knight Capital, and endless single-name examples), it might be nice to see a timeline illustrating just how prevalent these bots have become.

Lucky for us, the good folks from NANEX, specifically Felix Salmon, put together an animated example — using real-time data.

The video that follows illustrates trading volume across all major exchanges (the exchange ID’s are color-coded in the legend on the upper right corner).  The lower left corner shows the dates of the trades as they progress from reasonable volume in 2007 through being monkeyhammered by 2011.

It will take 30 or 40 seconds to get through all four years, but the wait will be rewarded as you see the explosion in volume as the dates approach the most recent.

Draw your own conclusion…

Here is the link:

http://imgur.com/DxWer

Of Books and Guillotines

Being a fairly boring guy with too much time on my hands, I tend to read a lot.  Much of what I read these days pertains to our capital markets — from postmortems of the 2008 crisis, to analyses of the 2010 flash crash, to wonky books on the nature of high frequency trading.  I also read some Stephen King now and then, which often leads to less horrific outcomes than those we often meet in the financial arena!

In the book “Confidence Men, ” one is left to decide whether government ineptitude or Washington/New York collusion placed the big banks in the profitable position they are today — after nearly cratering the global economy.  The part about Ken Lewis extorting $20 billion from Hank Paulson is terrific.

There were no heads on pikes.  Just rapid returns to profitability.

In “Dark Pools, ” (a book oddly lacking much content about actual dark pools but long on the surface level analysis of high frequency trading) a moral argument is put forth.  Should the fastest, most ruthless, amoral, wealth-mongering individuals be legally compensated with hundreds of millions of dollars while breaking down the very structure of our capital markets? (Note:  the value judgement is the author’s, not necessarily mine.)

The question is interesting in the abstract, but rhetorical in a world in which I watch stocks close on their VWAP (Volume Weighted Average Price) every day as if they were a jet being eased onto the runway by a skilled pilot.

We practice our trade in a world where the maker/taker fee system, set up by the exchanges, compensates the bad actors for the very behavior of acting badly.  But if my algo can swallow yours, (while creating trade volume, of course), good for me.  Price discovery be damned.

I’m not about to opine on the issue of societal good versus individual financial gain in this blog post.  It’s a discussion I’d welcome, if any readers would like to discuss it in the comments section.

It just strikes me that more, and more extreme, writings are cropping up that favor draconian resolutions to today’s (perceived or real) government/corporate exploitations.  The 1% is under assault; both for their level of wealth and the methods they used to attain it.

“You didn’t build that” might be better stated as “You shouldn’t have built that.”  You shouldn’t have built the “too big to fail” bank (with all due respect to Sandy ‘Born Again Financier’ Weill.)  You shouldn’t have built the algorithms that now constitute over 70% of the stock market’s volume while old-school investors recede into the shadows.  You shouldn’t have built a policy where bondholders were exempt from normal, market-based haircuts while the rest of the country was in financial flames.

But, I digress.  I often do.

After just having finished “Confidence Men, ” I started perusing the Wall Street Journal.   In the editorial section, I came across a very interesting question…  Would capital punishment for financial crimes be effective in quelling what we’ve been experiencing in the financial markets?  It’s a funny question in its absurdity, but the history of times when the question was not so absurd shines some light.

Rather than paraphrasing, here’s the link in its entirety.  Issac Newton and all.

http://blogs.wsj.com/totalreturn/2012/07/27/should-crimes-of-capital-get-capital-punishment/?mod=

Clowns to the Left of Me, Jokers to the Right

We frequently blog about the structural strains put on the market by algorithmic and high frequency trading.  We’ve also blogged (more than a few times) about the distortions in price discovery caused by central bank intervention, zero interest rate policy, etc. (most recently pointing out that 80% of the annual equity premium since 1994 was attributable to trading in the 24 hours before a Fed announcement).

This morning, however, saw a convergence of the two we seldom get to “enjoy.”

First, today’s episode of “Algos Gone Wild” was set at the NYSE, where 148 symbols began trading wildly and with ludicrous volumes at the open.  While there seems to be some linkage to Knight Capital, the specifics are not yet clear.  What we do know is that these stocks started swinging inexplicably by magnitudes of 10% or more.

A quote from a director of floor trading:  “Stocks are moving all over the place, they are weird, and they are trading like millions of shares 100 shares at a time.”

An example, provided by CNBC, would be Molycorp.  This stock traded 5.7 million shares in the first 45 minutes of trading.  Typically, Molycorp trades about 2.65 million shares per day.

If there is an upside to this story, the NYSE quickly halting the affected stocks may very well have averted another flash crash.  Small consolation in the scheme of things.

While the algo drama was unfolding, Louis Bacon put out a letter regarding his multi-billion dollar Moore Global Investments fund.  Bacon is voluntarily returning $2 billion to his investors, for the following reasons:

  • “The markets have been riskier and less liquid.”
  • “Markets are increasingly distorted by central banks’ attempts to squeeze drops of growth from an over-indebted private sector across much of the developed world.”
  • The US markets are hindered by “a caustic political environment and an anti-business administration.”
  • “The [Eurozone] banking authorities have been a special case in ineptitude, [waiting to raise bank capital] until it is largely infeasible.”
  • “Disaster Economics, where assets are valued based on their ability to withstand a lurking disaster as opposed to what they may yield or earn, is now the prism through which investors are pricing markets.”

Pretty strong words from the 238th richest American and uber-successful hedge fund manager since 1987.

To get some sense of how prevalent the Louis Bacon-type behavior has become in the hedge fund industry, Google “hedge funds calling it quits.”  Bring a cup of coffee, because you’ll be spending a lot of time reading your computer screen.

These are indeed weird times.  Navigating them requires extreme care in both capital allocation decisions and sizing of positions.

To paraphrase the 1972 song by Stealers Wheel:  “Fed to the left of me, algos to the right.  Here I am stuck in the middle.”

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Random Thoughts and Observations

  • Bill Clinton is officially “off the ranch.”  First, he announces that the Bush-era tax cuts should be extended.  Then, during his apology for the aforementioned comment, he noted that median family income is now lower than it was when he was President.  I never thought I’d miss Bubba, but his candor is kind of endearing.  Never mind his hanging out with porn stars in a Monaco casino.  I REALLY wish I could get this guy to come to a poker game at my house next weekend!

  • France lowered its retirement age for public employees from 62 to 60.  Really?  As your continent financially sinks into the sea, you tack on  a larger fiscal burden?  Granted, Hollande kept his campaign promise, but at some point Germany is going to tire of being slapped in the face by the French man-glove.  A quick read of Der Spieigel will give you some idea as to how soon that fatigue may set in.  I’ll give a clue…  next week.  Fetchez La Vache!
  • This week was the best week for the stock market in 2012.  The 285 point jump on rumors of Fed easing mid-week set the stage for the best week of the year.  Short covering continued through Friday.  I can’t blame the shorts for covering.  Watch for a hyped up European can-kicking announcement this weekend.  Those who are short US Treasuries and long European banks will likely have a nice day on Monday.  Two months from now those trades may not look so great.  But money managers are judged monthly, so many will live or die based on the rumour du jour.  Such is the world in which we live.
  • Despite the Drudge Report’s best investigating, nobody ate any new faces this week.  Time to go long faces and short Drudge, which has become shallow and pedantic.
  • Our President came out today and declared the domestic economy to be “doing fine.”  It may be, for those attending $40, 000 per plate parties at Sarah Jessica Parker’s house.  My anecdotal observations might provide evidence to the contrary.  But I’m loathe to get political on the blog.  I just wonder what he may be smoking.  Maybe the Choom Wagon made a stop in DC  this week.
  • UBS apparently lost $350 million as one of their traders on the Facebook IPO kept hitting the left mouse button over and over assuming his buy orders weren’t being filled since he wasn’t getting timely trade confirmations from NASDAQ.  He ended up owning 40 million shares.  Turns out he bought them at $42 then sold them at $30.  You can’t fix stupid.  Or bullsh*t.  Take your pick.  So, UBS is suing NASDAQ.  The great litigious American tradition.  I assume a “settlement” is in the making.   It shouldn’t, but does, yield a giant yawn.  Lose on your bet, get it back on your lawsuit.

Have a wonderful weekend, folks.