Are Flash Crashes like Hurricanes that are Unstoppable, and Only Predictable?
Bloomberg published an article Saturday titled, Toxic Orders Can Predict Likelihood of Stock Market Crashes, Study Says (Click here to read). A Tudor Investment researcher, Marcos Lopez de Prado, and Cornell’s David Easley and Maureen O’Hara, have together come up with an indicator called VPIN, which identifies the likelihood that market makers will curtail their activity. It apparently measures “order toxicity”, or “persistent order imbalances that will damage market makers”, or as we like to say at Themis, “losses.”
Tudor filed for a patent for this VPIN indicator, and Tudor’s Lopez de Prado suggests that creating a futures contract on the gauge could help market makers by providing a means for them to hedge against a May 6th-like risk. Ok. Timeout on the field. Flag thrown from the sideline. Let us review:
1) We have an insanely fragmented web of exchanges and dark pools, each run by different competing interests, many who cross own each other.
2) These destinations are connected by co-located high frequency trading firms, whose business models are solely to arb all the destinations, seeking out small price discrepancies among them to profit on.
3) Exchanges have found ways to insulate their profitability from market volume decimations by selling co-location, market data services, and feeds that are imperative for the edge that the high frequency firms need (see NSDQ’s earnings this past week) over investors as well as other HFT’s.
4) This market structure, or Market Unstructure, has as its goal the creation of arbitrage opportunities that pit all participants against each other, be these opportunities be from arbitraging new exchanges and destinations, or be these opportunities from arbitraging new ETF’s or derivatives, like the VPIN proposed above.
In the article, Paul Wilmott chimed in “Think of these models as being like an early warning indicator. Just like predicting a hurricane, you may know something’s on the way, but you don’t know where or when it will hit.” While Wilmott likens May 6th somewhat correctly as being like a hurricane, we see a huge difference: A hurricane is unpreventable. They are forces of nature, and not forces of man. May 6th was a result of flawed market structure created by man. We can correct the problem and flaws. It is not unpreventable. We haven’t given up on that. We think the better analogy is that of rewiring a classic car.
The Regulators need to get to the heart of the problem with our Market Unstructure, and correct it with intelligent reform that insures it will serve everyone (investors and traders of all speeds) as well as the capital formation process. Right now the only beneficiaries are the Exchanges who sell collocation and other market data services, and the “latency industry”. Investors are being harmed. Ironically, increasingly high frequency traders are being harmed. And most importantly, economic growth is being harmed.
Forget band aids like circuit breakers, collars, and increased market maker obligations (which won’t stand up in actual practice). Get rid of Payment for Order Flow (maker-taker). Make sure the SIP is not slower than the quotes the exchanges enable the big guns to recreate. And do something about these freaky enriched data feeds, which only serve the purpose of arming HFT predatory algorithms.
I have a good chart for you today. Everyone has their eyes on the FED for hints on what the QE2 will look like, and whether the Tepper Rally will continue after a little consolidation last week, or break down in a QE buy-the-rumor-sell-the-news fashion. I think this chart gives the clues correctly, and is from Richard Russell’s morning note out of San Diego:
Above you see a daily chart of the Dow going back three months. The first thing to note is the long blue ascending trendline. It continues higher until it hits a consolidation box. The box is defined by a horizontal line at its top and another one at its bottom. So far, the Dow is “caught” in the middle of the box; it hasn’t broken out to the upside or the downside.
Now note the red arrow at RSI. The arrow points to RSI heading down. Next note another red arrow at MACD at the bottom of the chart. Here we see MACD rolling subtly over. In both cases, RSI and MACD appear to be ready to sink lower. This suggests that the Dow will break out below the box.
Where we left off 4:00pm EST:
DJIA 11,118.49 +4.54
S&P500 1,183.26 -0.52
NASDAQ Composite 2,507.41 +0.04
Futures now at 7:30am EST:
NASDAQ 100: +9.75
Key Data out today:
8:30: Personal Income/Spending (estimate +0.4%)
10:00: ISM (NAPM) Index (estimate 54.5)
10:00: Construction Spending (estimate -0.5%)
Since the prior close, some key stories:
– Fat Finger trade in the currency market again? There was a sharp (and brief) drop in the yen overnight, prompting some speculation that the BOJ/MoF may have intervened again in the markets. However, the yen quickly rebounded, leading many to think it may have been just a “fat finger” trade.
– A new CNN/Opinion Research poll indicates finds Republicans have a 10-point lead over the Democrats in the generic congressional ballot, 52% to 42%
– European clocks set back an hour with the US poised to do the same next weekend.
– Goldman has considered moving up BONUS payouts.
– Cablevision. Fox and DISH reach programming deal.
– IBM in talks to buy-out Fortinet.
– SIA announced September monthly sales of $29.4 billion or a MoM increase of 15.5%, below the average September MoM increase of 23.3%. Total semiconductor sales in September increased 20.8% YoY, down sharply from a 31.2% YoY increase in August.
– Apple sues Motorola.
– Raytheon to sell up to $4 billion in arms to Saudi.
– Speculators further cut bets against the U.S. Dollar- CFTC
– China and the UK’s manufacturing PMI’s rise more than expected.
- Pre-open ACV, AEIS, AGN, ANAD, ASF, BHI, CTSH, ENDP, GLW, HUM, ICE, L, MCY, PTV, RE, SPG, WL, WRI;
- After Market Close: AFG, AXS, CTV, EXTR, FST, PFG, PPS, SANM, WFR
Significant Movers This Morning:
XCO +40%, FTNT +33%, AVP +19%, SUR +15%, CTB +7%, ACOR +5%, RTN + 4%, HK+4%, ANH -5%,