Flash Smash Revisited (Again)

I know this blog sometimes seems like a witch hunt for High Frequency Trading, but sometimes things happen that warrant a closer look.  This morning, there have been two cases of Algo’s going bonkers.  The first example, is Strategic Hotels & Resorts, Class C Preferred.  (Click on the image for a larger view)  Note in the Quote Matrix screenshot I cut from my Bloomberg, the “ask” for this security at 09:30:11 jumped to $2, 600.01.  Also note at 09:30:10 the preferred traded at $28.67.  The rogue trades were cancelled, of course,   and the security continued trading as “normal.”  Whatever that means these days.

How does a $28 preferred stock trade at $2600 in less than a second?

The next example is B & H Ocean Carriers and came to me courtesy of Direct Edge.  From their website, here is a description of Direct Edge’s business:

“Direct Edge, America’s newest stock exchange,  offers the next generation of displayed markets. With U.S. cash equities volume routinely exceeding 1 billion shares per day, Direct Edge uses multiple platforms and unique order types to match complementary forms of liquidity based on sensitivity to transaction cost, fill rate, and fill speed, while maintaining high execution quality and low latencies. Our innovative business model creates opportunities for the trading community unlike any other market center. This is what the future of trading looks like.”

The emphasis on “fill speed” and “low latencies” is mine.  Those are code-words for High Frequency Trading.

Whenever some “oddity” occurs on their exchange, Direct Edge sends an email identifying the problem and its resolution.  Here is the text of the email alerting me of BHO’s issue:

tradereview@directedge.com to me
show details 11:24 AM (23 minutes ago)

Direct Edge has determined to bust all trades in symbol “BHO” at and above $3.70 that were executed between 10:10:00 and 10:11:00 ET.

This decision cannot be appealed.

Seeing this, I checked out the stock action, and grabbed the following Bloomberg screenshot:

$3 to $4.20 and back.. in a hurry

Not only was the upward spike impressive, the severe reversal triggered SEC Short Sale Rule 201This stock has an average volume of less than 1, 900 shares, but has traded nearly 13, 000 in the first hour of today’s market.

While we don’t traffic in these types of securities in our business, the ability of computers to create such massive price distortions in under 1 second is troubling from a structural perspective.  While it is much more difficult for computers to flash highly liquid, higher priced names, the algos aren’t sitting by idly.  As they get faster and more sophisticated, their ability to distort the price-discovery mechanism in the market will only become more dangerous.

And those crickets you hear…  those would be coming from the offices of the regulators.