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Wednesday, July 01, 2009


high frequency trading and how the equity market can be broken

i've followed at a distance as the irrepressible tyler durden of zero hedge has pitched his case about the falseness of the massive short-squeeze rally that has run the market shockingly higher since mid-march on what (to my eyes) looks like very little or no economic justification. durden particularly has attacked the role of goldman sachs and others designated as supplemental liquidity providers as the agents of government intervention in the equity market. by no means a compendium of his huge flow of posts on the subject, i noted durden's views here, here and here.

now zero hedge notes the comments on bloomberg yesterday of joe saluzzi, trader for themis, an institutional trade execution service.

as it happens, saluzzi also keeps a fine blog himself where he has recently articulated similar thoughts to those expressed on bloomberg.

The market again has trouble not holding near S&P = 944ish. But not for a lack of trying! We witness each day the interpretation of data to be bullish (whether we agree or not), and we witness each day the post - 3:00pm program buying. The volume is light. It takes little to swing the market. But no matter; she is tired. The market is tired. The market is Wile E. Coyote.

I personally feel it is like Wile E. Coyote: The market is unable to just stop before the cliff. She tries to slam on the brakes,but it matters not. She shoots out over the cliff, skidding, amidst a skidding audio track, goes out over the cliff for 20 yards, pauses, looks at us, and then drops.

We have been looking closely at the market for a month skeptically, and now she is looking back.

and, much more informatively:

Over 60% of equity volume comes from the high frequency traders (HFT). ... [or more -- gm.]

HFT’s claim to be market makers and they claim that the liquidity they add to the market has lowered volatility and helped narrow spreads. But the problem here is , unlike a traditional market maker, they have no requirements. No minimum size to display, no minimum time to display a quote and no capital commitment to a client. ...

The HFT’s tried to prove that they add value to the market by referencing when the SEC banned short selling in 19 financial stocks last year. They noted studies that showed after this was enacted spreads widened by 40% and volumes decreased substantially. They said that since HFT’s couldn’t properly arbitrage the stocks, they simply did not participate. BIG RED FLAG should go up here. These HFT’s can simply walk away from the market when the rules don’t suit them. So what happens if the SEC enacts the uptick rule again or what happens if a major event causes turmoil in the market? Will these HFT’s simply shut down their computers and walk away since their model has been corrupted. What happens to that 60% of the volume that they now control? Where will all that LIQUIDITY that they claim they provide go when the market doesn’t suit them? A major vacuum will be formed in the market as multiple parties run for a much smaller than expected exit. ...

Our equity market is being controlled by machines that are nothing more than two bit, SOES bandits. They cloak themselves under the mantra of liquidity providers but they are really just locusts and are feeding off the equity market until it doesn’t suit them anymore. Once their profit margins are squeezed to almost zero, they are likely just to move on to a new market. But what damage would they have done? We will be left with a shell of a market that is used to being led around by computers. Real people and real capital are a scarce resource in today’s market.

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I've watched Tyler's posts go by too, and I can't tell what to make of it. If manipulation is occurring, the three big questions I'm unclear on are:

1. Is someone accumulating shares in order to achieve this effect, and if so, who?

2. Why would all markets be aligned in marching to the green shoots tune together (i.e., equities, bonds, global equities, CDS spreads, etc). Has any market diverged from the crowd meaningfully? (I think I saw something on Russian stocks...)

3. What would cause it to end? (You have highlighted one possible answer if this is driven by the will of the SLPs themselves and they have the choice to withdraw).

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ECRI has been pounding-the-table bullish on the economy -- they claim that their indicators started turning up even before the stimulus package was announced. They do not see any indication of a cyclical downturn in stocks currently.

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Depew is looking at the 944 level too.

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On a daily basis, support is 847.12, resistance 944.43. A close this week above 918.90 will set up the possibility for a qualified breakout for SPX on a weekly basis, which would extend the window of positive market forces.

we clearly didn't get 918.90 -- looks like 897 today.

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here;s some more via zero hedge re: saluzzi white paper.

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