You’re My Hot Rod Mama And You’re Really Built For Speed. Cough.
This was my favorite album back in the 1980’s. I love rockabilly, and Brain Setzer is some kind of guitarist, even more so today. He IS really built for speed! Ironically, however, the stock exchanges in place today are not. The large HFT customers that they rely on for their bread and butter, to whom they have sold out traditional investors, are simply faster than stock exchanges are. The Facebook failed IPO has demonstrated the danger of this in a very pubic way: the for-profit US stock exchange model (being replicated globally thank you very much), built on datacenters that serve up high priced data feeds, colocation server space, machine readable news feeds, and information-for-sale, has Face-Planted on a global stage.
We have allowed HFT to occur with no limits to their speed, and the Facebook IPO failed simply because the HFT firms are trading quicker than the exchanges can handle. And the exchanges that arm them , while insuring the lowest latency for their largest customers, have neglected to account for that speed when they perform what used to be their most important function – bringing companies to the public markets.
Some Facebook/NASDAQ IPO Facts
Fact 1: NASDAQ decided to allow continuous order submission and cancellation into the opening print.
Fact 2: NASDAQ delayed the opening from 11:00 to 11:05, 11:10, and finally 11:30.
Fact 3: Repeatedly pre IPO release, in time periods of between two- five milliseconds (thousandths of a second), cancellations “kept fitting in between the raindrops” in the time needed for the exchange technology to calculate the opening price.
Fact 4: The ultra-speed order submission and cancellations were not coming from retail or institutional investors; they just don’t operate through their front ends and web-based online brokerage accounts that quickly – they were coming from high frequency market makers.
Fact 5: Due to the fact that these HFT traders just simply operate faster than the billion dollar exchanges they trade on, the “rain drops” kept delaying the Facebook opening , so that NASDAQ made the decision to manually open the IPO at 11:30. Manually. The “raindrops” were, after all, causing bids and offers on NASDAQ alone to be CROSSED, which is not good for an exchange whose business is supposed to be the matching/trading of buy and sell orders.
Fact 6: Order revisions and cancellations after 11:10 went into a black hole. Investors retail and institutional alike did not know if they had bought or sold stock on the opening, or immediately thereafter, until 1:50pm and later. Firms that assumed that their black-hole orders to sell stock at the $42 opening print were unexecuted. Their profits became losses as they then scrambled to sell their IPO allocation at the end of the day, and even into the next day.
Fact 7: Knight estimates that their losses alone are $35 million.
Fact 8: NASDAQ, in an error account created just before the Facebook IPO, somehow managed to short/sell 3 million shares at $42, as their clients had not been able to. They made in excess of $10 million. Pretty good for an error where they sold at the high and covered near the low.
The bottom line? It is very simple. HFT traders are trading too fast. They are trading so fast that even the exchanges that arm them cannot keep up with them.
Almost two years ago (June 2nd, 2010 to be exact) at an SEC Roundtable on Equity Market Structure, there was a panelist named Dr. Michael Goldstein from Babson College. As an expert in market structure who has written countless academic papers on liquidity and spreads, he warned the SEC that there was such a thing as trading too fast, and that perhaps there should be speed limits on trading, lest there be unpredictable consequences. Pity his warnings were ignored. Pity for Facebook, Pity for investors. And pity for the reputation of our capital markets.