New book from Michael Lewis on High Frequency Trading

DQ, If you look at the market orders and follow Hunsader, yeah, his algo wasn't at work when the flash crash actually started. ... He had stopped spoofing the market 2 minutes, 32 seconds before. Which you are right, is like another lifetime in e-mini futures.

What is clear from the indictment (and when you see what Hunsader figured out was him), though, is that this guy was using dynamic layering to spoof the market. It was that "188/289" block algo. I am guessing this probably sounds like Chinese to a lot of people, but there is nothing really THAT sophisticated about it. Think of it as someone (using easy to create software) rapid-fire putting in orders to try to create market imbalances and then pulling the orders quickly and trying to profit from the imbalance they left behind. He had been trading that way over and over again for a while and did for several years beyond that. It's reckless and can actually backfire on you (if it goes against you, it can leave you in more debt than you will ever be able to pay back in 1,000 lifetimes -- which is why I think it is insane to be playing around with something like that). But this guy was for that whole period and for years afterward.

The indictment says he earned about $40 million over a period of years -- and pointed to him profiting about $879,000 that day. That is what I meant by right place right time. The market collapsed and he happened to be in the right place to clean up (as were others) -- but to the tune of less than $900,o00. To put it into context, the crash itself wiped out more than $1 trillion in value in seconds. This guy is such a small player in the relative scheme of things.

He was doing his little spoof algo for years, in a market filled with a dozens of other algos constantly at work -- by entities much larger than him. Yet we got that crash on just that one day. His algo didn't cause the crash. It's just ridiculous. He just happened to be active in the market at the time, and now his indictment is filled with nonsensical causation accusations that are trying to turn things that just aren't criminal into crimes -- with the rallying point being, "He made money during the crash!"

The only differences between this guy, and say Citadel (huge HFT firm), which I will bet with certainty was spoofing the e-mini market MUCH MORE vigorously day after day after day during that period, is that Citadel has a lot more money at its disposal to fight back with expensive lawyers and they are not an easily scapegoated foreigner.

So back to my other points on this thread: As much as the kneejerk is to try to criminalize that spoofing (either before or after the fact), to do so would be to destroy the markets themselves -- and all the liquidity that ETNs have brought to trading that have benefited everyone by bringing down transaction costs and tightening bid/ask spreads. These guys effectively play the role that human market makers used to play -- but much more efficiently.

That said, though -- and I said this early on in the thread -- is that the one systematic danger that HFT brings to the market is that all the volume they have brought into the markets has upped the volatility. Then all it takes is one leak or one panic (human factors!) to create chaos. I am certain that is what happened here -- someone on a trading desk leaked a huge volume of e-mini selling by a mutual fund and all the vultures on the trading desks at JPM, Goldman Sachs, etc. jumped on it at once. It was relatively harmless, but it also highlighted what could happen if, say, a foreign government wanted to bring our financial markets to its knees by creating a similar effect.

 

The "in good faith" thing is because the regulators are doing the asinine job of trying to determine whether orders are spoofs are not (i.e. -- whether you are actually putting the order on the hope that is filled, or whether you are trying to move the bid/ask spread and then pulling it).

Spoofing is illegal. The problem with that is that to determine if someone spoofed an order, you have to attribute motives to them! It's silly beyond belief. How do you decide that one order is "insincere" but another one is legit? It's ridiculous. Yesterday, I put in at least a dozen orders that I pulled. Was I sincere or insincere?

This is not something that should (or effectively can) be regulated. ... and have a free market. People have LOTS of motivations in a marketplace. That is what makes it a market! It's for the other participants to figure out if someone is trying to game the bid/ask spreads, and then adjust their behavior accordingly. Not for some paternalistic overlord to make the market "fair." It's fair if you just leave it alone. Otherwise you are chasing your ass, ignoring 99.9 percent of the people doing what you are supposedly regulating, and scapegoating people whenever you need to feed red meat to the newspapers for populist reasons.

Even if they COULD discern your motives and somehow stop spoofed orders (as opposed to people who are sincere when they place an order), it would be an even bigger disaster than a flash crash. They'd remove all liquidity from the market and create huge price imbalances that would make everything more expensive for people.

 

I'll say this about the guy. ... What he was doing isn't that sophisticated CONCEPTUALLY. I have sat at my screen many days thinking about what he was doing, knowing that it goes on and it was working for someone. Pull it off, though?

This guy had some technological prowess that is impressive. Especially knowing that he was working with software I have. He was making more money from his parents basement than a lot of the traders on the desks at the big investment banks, not with more financial acumen, but with a self-made IT advantage that anyone could have used. I really admire that.

He was also incredibly stupid people-wise. When the regulators came asking about his practices, he told them to kiss his ass (direct quote). A part of me wants to admire that, because in the same position I'd want to tell them to go screw themselves. ... and at the same time I am shaking my head. Just not smart. I wish him luck on fighting the extradition.

 

I don't know that that was what he was doing. There are HFT firms that spoof orders themselves to set up their trades. But it may be what he was up to. A trader named Michael Coscia was indicted a few months ago for doing exactly that. He was doing it very basically -- he'd put in relatively small buy orders lower than the best offer and then several bigger sell orders higher than the market price. The front-running algos would detect the large volume in play and sell on his offer, fulfilling his buy order. His algo would immediately cancel his sell order and reverse the process, with what he just bought offered for sale at a higher price -- tricking the front-running algos into buying them back from him (locking in his profit and their loss).

It's ridiculous that he is under indictment for this.

You are both are correct that spoofers (is that a word?) can keep HFT front-running (what started this thread) honest! If a front-run HFT algo tries to jump a spoofed order such as the one I just described, it will lose money. It takes what is guaranteed money for the HFT firms and adds risk into the mix, which takes away their advantage. And it has cut down on the amount of high-frequency trading! Which is why pretending like spoofing orders was something evil and trying to criminalize it is so dumb. It's all part of what MAKES the market.

Which gets back to what I have been saying. This is the nature of markets. There are people with various advantages, including different technological advantages. You can't regulate all of that away to make it "fair" (what does that mean?). ... and still have a market!

High frequency trading exists because of the technology we have all embraced (ECNs) which benefited us all -- it made the markets much more liquid, tightened bid/ask spreads (creating better executions with less slippage) and brought down the transaction costs for everyone. Electronic trading has saved us (in the aggregate) trillions of dollars. It's been a GREAT thing and has democratized trading.

With it came high frequency traders who try to gain a speed advantage so they can front-run orders. Those high-frequency traders, however, gave rise to some individuals developing algos that spoofed their orders to try to trick the HFTs. That is the natural kind of "regulation" of the market.

What these idiots at the CFTC and in the justice department throwing populist red meat out there do, is regulate in an arbitrary way that actually locks in the advantages for one group by criminalizing another group. And that is what creates the market imbalances that inevitably get filtered out on their own in an actual FREE market.