King Report: HFT



For the past several years Street operators have assumed that the computer jockeys who were being employed by proprietary trading departments on The Street were developing algorithms that would find other algorithms that represented buyside orders so prop desks could trade against those orders.

Another trading prop that has been occurring for years is certain firms feed their electronic trading systems into prop desks so traders can see in real time money flows into and out of stocks and groups.

However recent revelations are forcing the Street to consider the possibility of automated front-running on an unfathomable scale. The two ‘front-running’ issues are: 1) ‘queuing’ [of orders] – finding orders loaded into a system, particularly limit orders, and trading against them; and 2) ‘latency’ – discovering and then front-running electronic orders or a penny or more by exploding the latency or lag in execution.

HFT (high frequency trading) is being done on every electronically traded item on a global basis. Ergo, firms could be making pennies a few billions times per day…It was imperative for the NYSE and other exchanges to price securities in pennies to disguise ‘HFT’ & to provide ample trading opportunities.

While the Street is percolating with anger and curiosity about ‘High Frequency Trading’ there is also frustration and astonishment that the media, regulators and our duly elected are not addressing what could be the biggest financial abuse story of our times, if not history.

Though the blagoshpere is all over the ‘HFT’ trading story an important piece of the puzzle has not been publicized enough. Few people realize that exchanges actually pay firms to trade against order flow when they act as a SLP – ‘Supplementary Liquidity Provider’.

Exchanges will pay firms ¼ of a penny if they ‘provide liquidity’ when an order appears in their system. This is extra incentive to front run order flow… Theoretically a firm could ‘scratch’ all day and profit. The NYSE Euronext (Oct.24, 2008): A newly announced pilot program will establish Supplemental Liquidity Providers (SLPs), a new class of upstairs, electronic, high-volume members incented to add liquidity on the NYSE.

The program will reward aggressive liquidity suppliers, who will complement and add competition to existing quote providers.

o SLPs will be obligated to maintain a bid or offer at the National Best Bid or Offer (NBBO) in each assigned security at least 5 percent of the trading day.
o The NYSE will pay a financial rebate to the SLP when the SLP posts liquidity in an assigned security that executes against incoming orders. The goal is to generate more quoting activity,
leading to tighter spreads and greater liquidity at each price level.
o SLPs will trade only for their proprietary accounts, not for public customers or on an agency

Zero Hedge (May 5, 2009): Previously Zero Hedge observed the rather curious integration of Goldman Sachs within the fabric of the NYSE’s program trading environment, which, by their own admission, has everything to do with Goldman being the (monopoly) actor in the NYSE’s Supplemental Liquidity Provider program. I highlighted that the program was set to expire on April 30.

Today, unsurprisingly, the NYSE posted a notice of a proposed rule change extending the SLP program another six months, until October 1, 2009 (this does not change my commitment to providing weekly NYSE program data). I appreciate our readers’ existing and future feedback in this matter…

The full text of the comments by Jeffrey S. Davis of the NASDAQ Stock Market LLC is presented below, but here are some very relevant snippets:…

“NYSE fails to explain why proprietary liquidity is more valuable than agency liquidity, or why proprietary liquidity should be favored over agency liquidity. NYSE claims that the proposal is designed to prompt liquidity provision but it simultaneously disqualifies large liquidity

In NASDAQ’s view, these irregularities reveal that NYSE’s true motivation for the SLP Proposals is to discriminate among its members and to burden some members’ ability to compete with NYSE…”

And who is the one and only beneficiary of this rampant disregard for almost 80 years of market regulatory practice? Who is it that has now become the de facto provider of “market liquidity” which however has much more sinister connotations when reading through the comments of not just some blogger but the NASDAQ Stock Market itself?

When a firm has an 87.5% trading accuracy record, something unnatural is occurring. And we wonder why the buy side has been so docile and malleable when the money is being derived from them!

Over the past decade the move to electronic trading and pricing in pennies was heralded by Street insiders as a means to improve liquidity for clients. This appears to be a deception. Virtually every facility benefitted proprietary trading at a select few firms. Who’s the patsy?

Anyone with a modicum of industry experience understands that ‘providing liquidity’ is at best a euphemism for front-running order flow. Anyone that regularly ‘provides liquidity’ will go broke.

GS jumped yesterday on this: (BN) Goldman Sachs Trading Revenue May Beat 2007 Record. Goldman Sachs Group Inc. is on track to beat its 2007 trading-revenue record, enabling it to boost compensation by an estimated 64 percent from last year, according to Bank of America Corp. analyst Guy Moszkowski. Goldman Sachs has “unmatched risk-taking/risk-management skills in a market that strongly rewards these because of decline in competitor risk appetite,”…Six months ago, Goldman
Sachs was supported by $10 billion from the U.S. Treasury and relied on government guarantees to issue debt. Moszkowski predicts the company will reap $26.45 billion from trading this year, a gain from
$25.36 billion in 2007 when the firm shattered Wall Street profit records.

Remember this Bloomberg story from May? Goldman Sachs’s $100 Million Trading Days Hit Record Goldman Sachs Group Inc. reaped more than $100 million in trading revenue on a record 34 separate days during the first three months of 2009, up from the previous peak of 28 in last year’s first quarter… The first-quarter number was almost double the total for all of 2005…

Zero Hedge: Citadel Joins The Program Trading Industrial Espionage Fray, Sues Malyshev And Teza The gloves are now completely off in the escalating program trading fiasco that was started by Goldman’s former Sergey Aleynikov. Oddly, while Zero Hedge was fully expecting the Teza injunction to come from Goldman, it seems Griffin was more than happy to burden himself with that task. Hopefully Citadel is not faced with a case of reverse discovery and forced to document the 40% returns that it generated compliments of Malyshev when all its other groups on average lost around 50% in 2008.

Bloomberg: Citadel Investment Group LLC, the $12 billion hedge fund firm founded by Ken Griffin, sued three former executives and the firm they founded, Teza Technologies LLC, claiming violation of non-competition agreements…

Teza described itself in a July 6 e-mail as a “formative” firm that is neither trading nor investing. Named after a river in western Russia, the Chicago-based firm was co-founded by Misha Malyshev, Jace
Kohlmeier and Matt Hinerfeld. All were named in the complaint…

Malyshev worked at Citadel for almost six years and until February was its head of high-frequency trading… He was on the team that ran a $1.8 billion tactical trading fund that uses computer model to make trades every few seconds. The fund climbed 40 percent last year, while its main funds tumbled 55 percent.

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