Dreaming? New SEC 2012 Concept Release on Equity Market Structure Part I

17

May, 2012

 
SEC Issues Updated Concept Release on Equity Market Structure
FOR IMMEDIATE RELEASE
2012-54

Washington, D.C., May 17th 2012 – The Securities and Exchange Commission is seeking comments on its revised Concept Release on Equity Market Structure. The original Concept Release sought commentary on issues ranging from high frequency trading, to co-locating trading terminals, and to markets that do not publicly display price quotations. After an excess of 325 comment letters from a diverse and varied market constituency that included brokerage firms, dark pool operators, stock exchanges, money managers, and retail investors, the Commission has decided to revise the framework for examining our markets, and seeks commentary.

While the initial Concept Release focused on many issues, and especially Market Quality Metrics, Fairness, High Frequency Trading, Co-location, and Dark Liquidity, this update seeks to further frame what the best market structure would be that allowed for healthy interaction between traders of all speeds, investors, and corporate issuers, as well as allowed for capturing the efficiencies of substantial technological efficiencies introduced by technology.

We will update our Concept Release on Equity Market Structure by examining issues in three parts, of which Part I is this first request.

Part I

I. What effects, both positive and negative, have payment for order flow mechanisms had on the quality and fairness of our markets? Specifically :

a. Has the practice of selling retail order flow harmed retail investors and traders? What effect has the practice had on the quality of order flow on the public markets? Have disincentives been introduced that have deterred the provision of longer term liquidity on limit order books?

b. What effects has internalization had on investors? Is sub-penny price improvement enough compensation for investors to justify financial modeling and advanced previews of order flow before they arrive in the market place?

c. Does the maker/taker pricing model on the various stock exchanges distort pricing in the markets? Does buying and selling to maximize rebate-garnishing business models distort the price discovery innate in the traditional supply/demand model, where participants buy because they feel the asset will appreciate in price, and sell because they feel the asset will depreciate?

d. How should the Commission view “pricing innovation” when deciding whether to approve or disallow a new trading venue?

Parts II and III will be released in coming weeks, and we are eager to hear your viewpoints.

(Themis Note: This is not a real SEC Release or Request for comment. It’s what we call sad-tire)

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Trail Of Cookie Crumbs

16

May, 2012

A recent paper titled “The Volume Clock: Insights Into The High Frequency Paradigm”  takes a very different approach to analyzing the effects of HFT.  The authors (Easley, Lopez de Prado and O’Hara) concede that even without their speed advantage, HFT would still be able to exploit institutional and retail orders.  They note that HFT takes advantage of market microstructure factors that have been created due to regulations like Reg NMS and MiFID.  They claim that the Efficient Market Hypothesis is no longer valid in an HFT world and that over short intervals, “prices are predictable artifacts of the market microstructure“.  The authors state that “HFT reacts to information leaked by LFT (low frequency traders) in order to anticipate their actions“.   In other words, institutional and retail orders are leaving a trail of cookie crumbs that HFT’s are easily sniffing out and using to their advantage.

Indeed, not only does this paper point out that HFT’s take advantage of the predictable actions of institutions and retail, but they claim that predatory HFT can actually cause these events to occur:

“Rather than possessing exogenous information yet to be incorporated in the market price, they know that their endogenous actions are likely to trigger a microstructure mechanism, with foreseeable outcome. Their advent has transformed liquidity provision into a tactical game.”

Examples of this behavior are quote stuffing, quote danglers, liquidity squeezers and pack hunters.

While highlighting these dangerous predatory HFT behaviors, the authors do seem to give a pass to the HFT automated market makers.  They claim that these predatory activities even harm HFT market makers and that HFT market makers “sometimes may suddenly pull all orders, liquidate their positions and stop providing liquidity altogether.”  We think this is a major problem.  Our market has replaced traditional market makers that had quoting and trading obligations with HFT market makers that can now suddenly pull their quote at the sign of trouble.  This is the real problem with our markets but let’s get back to the paper for now.

The authors also highlight an example of predictable behavior that HFT’s take advantage of:

“There is no question that the goal of many HFT strategies is to profit from LFT’s mistakes.  We have taken a sample of E-mini S&P500 futures trades between 11/07/2010 and 11/07/2011. We have divided the day in 24 hours (y-axis), and for every hour, added the volume traded at each second (x-axis), irrespective of the minute. For example, E-mini S&P500 futures trades that occur at 20:20:01 GMT and 20:23:01 GMT are added together.10 This analysis allows us to see the distribution of volume within each minute as the day passes, and search for LFTs executing their massive trades on a chronological time- space. The largest concentrations of volume within a minute tend to occur during the first few seconds, for almost every hour of the day. This is particularly true at 02:00-03:00 GMT (around the open of European equities), 13:00-14:00 GMT (around the open of U.S. equities) and 20:00- 21:00 GMT (around the close of U.S. equities). This is the result of TWAP algorithms and VWAP algorithms that trade on 1 minute slots. A mildly sophisticated HFT algorithm will evaluate the order imbalance at the beginning of every minute, and realize that this is a persistent component, thus front-running VWAPs and TWAPs while they still have to execute the largest part of the trade.”

Pretty simple stuff that even a “mildly” sophisticated HFT algo can detect.  Good luck human!

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More Spy vs Spy: SXP vs Quantlab

14

May, 2012

Sen. Schumer Attacks The Maker/Taker Model

11

May, 2012

Munger: Strong Leadership

09

May, 2012

Their 2 Cents Ain’t Even Worth 2 Cents!

07

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New Academic Paper Says HFT Does Increase Volatility

04

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Monkey See, Monkey Do

02

May, 2012

The Flash Crash of 2010: Happy 2nd Anniversary

01

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The Winds Of Change

25

Apr, 2012