May 6^th was a defining moment in the history of US Trading Markets, if not Global Trading Markets. It certainly exacerbated an exodus of investor funds from our markets, as investor confidence plummeted in how we have allowed such a crucial part of our capital formation process fall victim to a little-understood, and yet pervasive participant. Eventually there will be a book. There will be many. Hopefully at least one of the books will tell the truth and not serve as propaganda for an unfair, yet entrenched business model.

For now, consider this analogy. Many species venture down to the water hole to drink. They do this under normal conditions knowing that there are risks of predators around the watering hole. If the water recedes, and the same number of crocodiles is in the hole, how do you like your odds for a drink now?

We think the SEC did do itself a disservice with its flash-crash report. The expectation by nearly all was for a report that dissected the events of May 6^th, and that outlined fixes it intended to implement, so that May 6^th could never happen again. The report did the former, but did not do the latter, outside at a hint that circuit breakers would be expanded and altered with limit-up and limit-down.

We read through the entire report, and were struck by several things; some of these things were findings in the report, and some were things that were glaringly missing from the report. This week we will each day take one of these issues and highlight it in Themis Thoughts. We will also at some near point in time piece all of our thoughts together in one report as well.

For today we would like to highlight what the SEC started discussing on page 50 of its 104 pager report; the issue whether HFT firms were more on one side of the market during the heavy selling, and vice versa on the way back up. In the six day period leading up to May 6^th, the 17 HFT firms the SEC examined averaged trading 44% of the dollar volume of trading, where 51.5% of that trading was aggressive HFT liquidity-taking, and 48.5% was liquidity-providing. The higher % for HFT liquidity-taking does not surprise us, as we know that there are more kinds of HFT than “market making”, and that some of those other types are geared towards detecting institutional footsteps and running ahead of them aggressively. Unfortunately, we were also not surprised to see that the data supports that

“the 17 HFT firms escalated their aggressive selling more significantly than any other category of trading during the rapid price decline in the period ending 2:45pm… In general it appears that the 17 HFT firms traded with the price trend on May 6^th, and removed significant buy liquidity from the public quoting markets during the downturn.”

We do realize that certainly part of the reason for this was that the HFT firms were long from playing hot potato in the E-Minis, and were trying to flatten their exposure, yet it highlights two things we think everyone needs to focus on. First, our structure that allows for-profit exchanges to sell speed advantages to the highest bidder, has allowed exactly the type of two-tiered market that we had thought we had fixed in the post 1987 stock crash. At least 17 speed-advantaged co-located firms had access to pricing, and liquidity, that slower participants did not have. Second, if the data supports that HFT did this on May 6^th, does this not fly in the face of what has been stated repeatedly by countless pro-HFT defenders, ranging from CEO’s of financial institutions to actual regulators? They are on record saying that HFT stabilizes wild price swings by “taking the other side” and “buying on the way down”. They are on record for saying that HFT also stabilized in the fall 2008 meltdown. The data in this report finds the opposite. Let us quote from what we wrote in Themis Thoughts on May 7^th, the day after the Flash Crash: “To make matters worse, while some high frequency firms shut down yesterday and pulled their bids, as we warned they would do for over a year and a half, other high frequency firms turned from being liquidity providers to liquidity demanders, as they turned around and indiscriminately hit bids like Randolph and Mortimer Duke.”

Think about those two things today as everyone else demonizes a Kansas City money manager.