Wall Street meets The Matrix

July 30, 2009

Michael Durbin is no Wall Street rebel. But Durbin, who has been on the front lines of
high-frequency trading (HFT) since its early days, isn’t afraid to buck the industry line that lightning-fast trading of stock, options and commodities poses little or no risk to the stability of the markets.

Durbin says it’s reasonable to wonder whether Wall Street’s unfettered embrace of algorithmic automated trading could be setting the stage for a future meltdown.

“You have multiple HFT trading firms and sometimes their agendas are complementary and sometimes they’re not,” explains Durbin, director of HFT research with Blue Capital Group, a small Chicago-based options trading firm.

“There could be a time where these HFT programs unintentionally collaborate and you have a two- or three-minute period where the markets are going crazy. Then other traders respond to it and it simply gets out of control.”

What Durbin’s talking about is the dreaded contagion effect, in which a bad trade or a rogue algorithm misfires — sparking copycat sell orders at other high frequency desks.

It’s the kind of machine-driven crash that sounds like the plot line for “Wall Street” meets “The Matrix”.

High frequency trading programs are designed to scour the markets to decipher trends in trading patterns and place buy and sell orders a millisecond ahead of the pack. It all happens at warp speed, and except for developing the algorithmic programs, the human element is all but gone from the equation.

And with high frequency trading desks accounting for the majority of daily trading activity in stocks, options and commodities, Wall Street has become a place where machines are often trading with machines. The potential for something going awry is real, if one of those machines malfunctions and the humans minding the store aren’t quick enough to pull the plug.

Can anyone say “I, Robot”?

Durbin certainly has the bona fides to speak to the potential risk. Before joining Blue Capital, he worked for two years at Citadel Investment Group, constructing the hedge fund’s high frequency trading desk for stock options — the largest in the business.

Durbin published a popular layman’s guide to derivatives in 2005 called “All About Derivatives” and has taught several finance classes at Duke University. Paul Wilmott, a leading expert in quantitative finance and a founder of a hedge fund that specialized in algorithmic trading strategies, recently wrote in The New York Times that “the problem with the sudden popularity of high-frequency trading is that it may increasingly destabilize the market.”

That’s enough for me. It’s high time for the Securities and Exchange Commission, the Commodity Futures Trading Commission and overseas securities regulators to start working together now to assess the potential systemic risks posed by high frequency trading before a problem occurs.

Now, the proponents of high frequency trading naturally dismiss all this doomsday talk as utter nonsense.

Big players in the field like Goldman Sachs, Citadel Investment Group, Getco and Interactive Brokers claim they’re mainly providing liquidity — making it easier for other traders, institutions and investors to get in and out of positions. The vast majority of high frequency traders would have you believe they are nothing more than service providers.

Yet it’s fair to question the necessity of the service that high frequency traders say they are providing. Much of the liquidity high frequency traders are adding to the mix is simply to match trades created by other high frequency traders.

Want proof? Look at what’s happened with stock options trading in the United States over the past decade.

In 1999, some 445 million stock option contracts were traded, according to The Options Clearing Corp. A year later, when the International Securities Exchange opened for business, annual trading volume jumped to 672 million contracts.

But stock options trading really began to surge after Citadel, Interactive Brokers and a handful of other brokerages and hedge funds jumped head-first into high frequency trading in 2003. So by 2004, a little more than 1 billion contracts were traded. And in 2008, some 3.28 billion contracts were traded, according to the OCC.

That big increase in trading came from a rather exclusive club.

Again, it’s premature for anyone to suggest that regulators either prohibit or severely restrict high frequency trading. But let’s be clear what we’re talking about here — this is mainly trading for trading’s sake. High frequency trading is simply another way for Wall Street firms and hedge fund to make money.

There’s nothing inherently wrong with profit-driven trading. But if high frequency trading isn’t critical to keeping the markets humming, there should be nothing stopping regulators from putting a review of this strategy at the top of their agendas.


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[...] involvement in the Aleynikov-GS scandal). We present to you Michael Durbin, who tips his cards in a piece by Reuters’ Matt Goldstein who broke the Aleynikov [...]

[...] Matt Goldstein: Wall Street meets The Matrix [Reuters via [...]

Yes, they say they provide liquidity but is it really true?
Providing liquidity means to buy stuff, if you sell stuff you are said to remove liquidity.
For every buyer there is also a seller and since computers trade with computers, computers are on both ends and liquidity is thus removed as quickly as it is ‘provided’.
Since no side will only buy or sell, they just exchange roles after some time.
Money than is made on exchanging the roles of buyer and seller, pocketing the commissions and fees and not worrying to much about the value of equity being traded. Keep in mind,however, this also works the same way for derivatives such as options.
This means that volatility is actually good for the algorithms, because money can be made by using these price swings. So if you can’t make money on the rising share price, you will make money on the options you are also holding.
In addition, I am pretty sure that the game is completely programmable and thus predictable. With these algorithms, you’ll simply know where prices are going to go – at least the companies who run the algorithms know.
This game is completely rigged in my view.

The algorithms were build to detect patterns and act upon them, and there is more HFT the patterns are more and more determined by other HFT algorithms.

These algorithms will likely trade themselves to a single victor if there are no limiters set in the code; any other equilibrium is highly unlikely. When this happens the market will be determined by the HFT algorithms and most of the companies that opperate HFT will see massive losses, and a few will see massive gains. The stock prices will also be a mess after they are done.

But noone wants this to happen so each company that opperates HFT limits how much money the gamble on their algorithms at any given time. They know that there is a point where things will go unstable and nobody wants to be the one that gets the market there.

But even if each company keeps an eye on them selves, the combined pool of money in HFT is something that is secret. So noone really know what percentage of the market is determined by HFT. And noone really knows how close or far we are from things going wobly.

Noone wants these algorithms to get regulated, noone wants to prove that their algorithms will follow all the SEC rules. Since chances are that the black boxes have probably figured out that there is good money to be made in manipulating the price rater than predicting the price. And even if we never told the algorithm to do this, we also never told the algorithms not to do this.

Posted by Bas | Report as abusive

look at the history of hede fund collapses before and after electronic trading – bring back the human eleement bring back actual people making decisions – the only use for electronic platforms is to generate fees for exchanges

Posted by mark | Report as abusive

Antonio Ivan Easterling
Chaplain; Editor-in-Chief
The Proletarian Review

The GAS Law

1. Yes, I want high-speeed computers business networks bridled in Wall Street tradining, even more so, I want the GAS Law. A General Accounting System (GAS)to enforce compliance when trading bonds, stocks and options.
2. When personal and professional life-saving are at-risk, and after the biggest banking debacle in business history, tracking assets, cash, credit and equity is the order of the day forever and forever, amen. Wall Street is the last glimmer hope for the Proletarian Class in the United States of America to enjoy the 14th amendment to the United States Constitution. Since the Middle Class professional (White Collars) have destroyed any hope and promise that laid in this country. Well, let the Proletarian Class (PC)take charge of Wall Street under the Sarbanes-Oxley Act of 2009 to ensure and assure that 20 percent of someone Social Security expenditure or 100 percent of a Proletarian personal retirement is protected by banking statues and the iron-clad will of the United States Armed Forces, as well, as globalized NATO forces on-the-ready. For this reason, any fraud and/or violation of the GAS Law is considered a blantant act terrorism against the people of the United States of America and our Public Trust. An accounting problem will be charterized as an act terrorsm. This is why Flash Trading should be against the GAS Law and/or the Law, period.

Antonio Ivan Easterling
Chaplain; Editor-in-Chief
The Proletarian Review

Posted by Antonio Ivan Easterling | Report as abusive

Supporters of HFT claim that this programmed trading provides liquidity to the markets. Traditionally, this would mean more activity, leading to tighter spreads. Yes, there is increased activity, but has it lead to tighter spreads? To myself, and other non-computerised traders who are getting far worse fills than expected, it seems that this is more a case of an increase in volume with far WIDER spreads. This is all down to the additional slippage that these HFT machines are introducing in order to skim profits off as many trades as possible where they act as a middlemen.

When you look beneath the glossy hi-tech surface of HFT trading and dark pools, it seems increasingly like we are now in the age of the computerised bucket shop.

Posted by Stuart Wheeler | Report as abusive

There is no industry on the face of the earth where participants have been forced to transact at speeds beyond human capabilities except in the modern world of equity / high frequency trading. This serves no purpose to anyone but those who seek to profit unfairly at everyone’s expense. The integrity of the marketplace is at stake.

Posted by Deferrd Comp | Report as abusive

[...] Wall Street meets The Matrix – Reuters Blogshigh-frequency trading (HFT) since its early days, isn’t afraid to buck the industry line that lightning-fast trading of stock, options and commodities poses little or no risk to the stability of the markets. Durbin says it’s reasonable to wonder [...]

[...] Wall Street meets The Matrix – Reuters Blogshigh-frequency trading (HFT) since its early days, isn’t afraid to buck the industry line that lightning-fast trading of stock, options and commodities poses little or no risk to the stability of the markets. Durbin says it’s reasonable to wonder [...]

One has to agree that idividual stocks should also have circuit breakers if the market itself has them, however, one also has to wonder with the speed of the machines so ever increasine and market rates going ever so higher will the circuit breakers be fast enough to stop the perfect storm.

[...] For now we can count on continued fraud and bogus rallies. Wall Street lives on front-run trades, robot controlled high frequency manipulation, and racketeering. This is in addition to the trillions in  derivatives yet to be play out. [...]

[...] For now we can count on continued fraud and bogus rallies. Wall Street lives on front-run trades, robot controlled high frequency manipulation, and racketeering. This is in addition to the trillions in  derivatives yet to be play out. [...]