Einstein and the Great Fed Robbery
nanex.net
nanex.net
Assume the probability of a losing day is just .02 (i.e. 2%, which is rather good). A quarter has 60 trading days. Then
.98^60 = .297+
which means it happens just once every 3 times. But that is a magician doing business.
If the probability of a single losing day is .1 (one out of ten, good for humans, I guess), then the odds are
.9^60 = .00179+ (once every 500 times) =(less than once in a century)
So, really really spooky.
Of course "once in a lifetime" events happen quite easily in the Stock Markets, but they tend to be negative (Long-term Capital Management, today's crisis...)
Sorry (lots of edits because term=60 days)
I guess.
IIRC, obviously.
And in any case, all you have proven is that we can reject the null that the distribution of JP morgans daily returns this year, was different to the distribution of their daily returns in previous years.
Let's leave guilty-by-rejecting-the-null-in-an-artificial-model to the courts and not let their logic infect HN too. All that's been shown is that JP Morgan have had 0 days with a trading loss. No one has actually shown they did anything wrong, or even explained what they might have done wrong.
Traders do exactly this, it is the service they provide. It is quite unlikely that all the traders in a big bank are going to lose money on the same day.
(1) Banks carry hedged books. You expect to win more frequently than 49 out of 50 times if you're instantaneously buying and selling FX in different regions, or delta hedging an option book.
(2) The riskier assets also tend to be illiquid. This delays loss recognition, not necessarily out of deviousness, but because nobody realises the loan in question is a dud until someone tries to market it.
(3) Market returns are not i.i.d. They are correlated. This makes streaks more likely.
This is what Nick Leeson did which brought down Barings Bank, and what Jerome Kerviel did to SocGen. I'm sure it happens all the time.
I watched a very strange film, a comedy, called Kung Fu Mahjong [1] in which the central theme are ladies that play Mahjong. And what struck me, perhaps as a westerner, or perhaps it was intentional, was that everyone in the movie cheats in some way or another, and everyone knows it. It reminded me of the kinds of things you would read about in the HFT blogs and forums. You could make a 'Kung Fu HFT' movie with the same theme.
The bottom line is that I have very little sympathy for these guys. As the 'early release' scandal broke and then was documented it felt like more crap to shovel out of the door and not like any sort of progress toward a more durable system.
For instance, after NASDAQ went down for 3 hours on August 22, the SEC asked the NYSE and NASDAQ for a detailed timeline of events. Each exchange blamed the other. The SEC's response? It told the exchanges to cooperate and please fix the problem, declining to make any further public comment [1].
Trading at high speeds is like the wild west right now with little to no threat of law enforcement.
[1]http://uk.reuters.com/article/2013/08/27/uk-nasdaq-halt-nyse...
It's actually not super complicated. A limit order book is a straightforward thing. If you can do FizzBuzz, you can probably whip up a toy implementation of a matching engine in an afternoon. People think it's complicated because of all the FUD (c.f. the comments on this story), but the basic mechanics of how a modern exchange operates are remarkably simple.
I'm referring to market microstructure in terms of the complex interactions amongst exchanges, the impact of Reg NMS, etc. Obviously the underlying algorithms can be boiled down to simple components.
For those interested in learning something about market microstructure, I highly recommend "Trading and Exchanges: Market Microstructure for Practitioners" as an introduction to the basics:
http://www.amazon.com/Trading-Exchanges-Market-Microstructur...
I've heard that the financial interconnections are remarkably similar to ecologies. Would be interesting to get some more of that tooling for analyzing ecologies like fisheries available to financial regulators.
That is fantastically complicated. As you say, anyone can write a matching engine.
The tediousness could be relieved by centralising market microstructure documentation. But given the frequency with which we change rules, it may make more sense to have an expanded class of lawyers or risk managers who are dedicated to understanding and promulgating the documentation.
I wouldn't go so far as to say the SEC, Finra, or the Fed Market Surveillance teams don't have a strong handle on microstructure - they have smart people. The SEC's job isn't to manually fix problems. It would be troubling if every time an exchange went down the SEC felt compelled to issue a new rule.
Trickster hero.
They're present in every mythology the world over.
Thinking sideways is a natural thing to encourage. A particularly subtle and cunning piece of underhanded trickery, once the cards are on the table, is impressive and laudable. The real trick is to not be a dick about it; when you win, you need to learn to share your winnings, to communicate that it's just a game and it wasn't personal and you weren't trying to hurt the others.
The problem isn't that the banks and funds and such are cheating. The problem is that they're causing damage and failing to genuinely express remorse over that damage.
That the banks can "cheat" is indeed a problem.
Banks do serve a useful purpose - dont get me wrong. But i think lately, the value a bank is adding to society is somewhat deminishing, compared to the burden they weight. A bank makes its profit by "taking on risk" of loaning capital to someone who doesn't have it, and extracting the surplus generated by the capital (ala, as interest on the loan).
This is ok, as long as the capital is used to generate "real" wealth - that is, production of goods and services. I feel that at times, a lot of loans are not used to generate product and services, but to "gamble" (ala, stock market?, buying and selling as a middle man ?). The process a bank goes thru to loan money creates extra currency, and this extra currency, imho, is what causes inflation. In fact, so much of economic activity is now tied to bank loans, that a failing bank means collapsing a corner of a table.
But i have no solution - as long as the illusion of stability is maintained, the system works. When it breaks, its chaos, but so far, all chaos has been prevented by either bailing out, or some other form of tax payer funded activity. Meaning, some people/organizations are using this as an opportunity to profit as a parasite of this system.
Here, check this out:
http://publicbankinginstitute.org/
I'm not much of an advocate for this solution because, frankly, I don't understand it well enough. Insofar as I do understand it, I feel that it's worth supporting it, or at least being more widely considered. My lit review of reasons not to do it turned up no convincing objections (and I've asked different groups for help several times over the past 5 years).
How exactly are you arriving at your minor premise here? My reading is that other people want to compete, but are unable to do so effectively because of (alleged) cheating.
I think his premise is that people are mad because they can't compete because they don't have the resources (money) to do so. If they were able to execute trades as fast as the big guys, they would be perfectly fine with the practice continuing. Since they don't have the cash to compete they are upset because they see someone else making money where they cannot.
I imagine anybody owning a bike should be able to compete with UPS in delivering packages, and the fact that UPS owns a fleet of trucks, planes, warehouses and complicated logistics software just makes it all unfair. If only one would be allowed fairly competing with UPS by having them deliver packages as slowly as single guy on a bike, or alternatively if the government would create a bike that could fly like a jet plane - that would be fair.
I imagine one guy with a saw should be able to fairly compete with a logging company, and one guy with a bucket and trowel should be able to compete with construction corporation, and one guy with a screwdriver should be competing with Boeing and Lockheed Martin.
When that happens, I think we could take comparing a guy using etrade.com from his macbook with trading division of JPMorgan Chase. Until then - yes, they're playing in different leagues, as it always is in the world. There's nothing unfair about it.
Nobody is (or should be) mad with people trading on fundamental performance and clean, authentic risk-taking.
So, what is your point?
Suppose instead that exchanges buffered all orders for, say, 1 hour. At the end of the hour they perform a stable matching algorithm to pair up bids and asks, and execute those trades simultaneously.
Are there any downsides to this? It seems like it would eliminate all of this zero sum behavior, and at the same time, increase liquidity, particularly for people who aren't on a fiber line one block from the exchange. You could additionally require all material information to be released at the top of the hour, to ensure a full hour of analysis before any trades are executed.
Only by when the market is efficient (in the technical economic sense) is it non-exploitable by smart guys. Efficient markets require all players to be rational, so not in this world.
As long as this asymmetry exists, the vast majority of trades will constitute a zero sum wealth transfer.
There are issues with regulating markets (serious ones given the imbalance of resources between regulator and banks you point out), but it is not impossible.
This is simply false.
They merely require that the net sum of trades of the irrational players is not significantly larger than the total depth of the market.
tl;dr; Knight Capital was wildly irrational on at least one occasion. The market remained efficient and simply took most of Knight's money.
There are problems with the low latency trading, and some unscrupulous behavior, but it's not entirely bad. In general the low latency guys do provide liquidity, and tighten bid-offer spreads.
Some thoughts on addressing the issue: implementing this sort of thing entirely on the server side would be a colossal engineering effort, and probably involve adding new "fill conditioned on state of other order (on a different exchange in a different country)" order types. A naive implementation of these conditional orders as described permits causal cycles where taking the shares causes one to take the shares, and not taking them causes one not to, and then one wonders whether the exchanges (the many worldwide exchanges that are collaborating on this algorithm) should have the order take the shares or not! A similar causal cycle may occur in which taking some shares causes one not to take the shares and vice versa. Regardless of what resolution is chosen for the "paradoxical" case, it will undoubtedly be a significant undertaking for both mathematicians and bakers to discern the correct combination of order types to maximize EV or to minimize risk, and to choose between maximizing EV and minimizing risk each time a position involving more than one instrument is traded.
Alternately, we could allow each exchange to make its own rules. They might end up with rules that are actually possible for human engineers to implement, like "price-time priority".
If I want to enter a large hedged position using the same "send some orders, wait for the fills, send more orders to tweak one side to be the appropriate size" procedure, I want to minimize the potential for price movement between the first and second sets of fills. If one hour's worth of information is incorporated into the securities' prices between the two sets of fills, that is a really huge amount of exposure compared to what I would expect today. I would have to be believe that the EV of the position is quite large before accepting one hour's unhedged exposure to get in on it. I could try to get rid of the round trip by using market orders everywhere, but this doesn't actually sound less risky. My belief and knowledge of the trades at some particular time would have to justify entering the position at some unknown pair of prices an hour later.
The great many participants who have not-incredibly-strong beliefs about the value of some hedged position will just not trade. The absence of their trades is a loss of information to the market; the market is less efficient. We probably share the belief that a more efficient market is good and a less efficient market is not so good :)
Enough with the hedged positions though!
Normally for this type of proposal I can just answer "If we do this then spreads will get bigger and that's bad," but here I have trouble doing that, because I'm not even sure if the notion of a spread or an inside price would make much sense once everything is so illiquid. Rather than having a view of the market that is a bunch of orders I can interact with at will, I would instead have a record of all the trades that happened in the last timestep and which orders were intact at the end of the last timestep. This is probably not sufficient information for me to learn the best prices at which I can be certain to buy or sell.
I don't think it's accurate to call what's going on today "an hour's worth of information." Not that much happens in an hour, per stock. It's more akin to an hour's worth of random walk. This is harder to argue, but I think this scheme would cause most of that random walk to disappear. Certainly whatever component of it is second order would disappear, (that is, based on signaling from the price movement itself.)
>I'm not even sure if the notion of a spread or an inside price would make much sense once everything is so illiquid.
If you think of liquidity in terms of "the chances that I can sell without having a large effect on the price of the stock" then I think this only increases liquidity. You're no longer counting on the availability of moment to moment orders on the other side of the deal. You're essentially building a smoothing function into the market.
Why do you believe a narrow spread is unneeded when the market is stable?
...and removes it when you do aka the market is crashing.
Selling liquidity is an extremely high-profit activity during periods of high volatility.
HFT no longer provides liquidity when the risk of broken trades is high.
Also, from an information theory perspective high frequency trading can't aid price discovery...
Simply false. See here for an explanation.
Market makers don’t directly participate directly in the price discovery process. A high frequency trader, or any sort of market maker, has no opinion or information on whether Apple is a valuable company.
Further buying or selling within the spread does not automatically make money it's as there is risk which that article mostly ignores.
Similarly, network engineers don't gather news, but they still help the news get out.
PS: There was a while that I accepted the idea, but consider what happens if bill gates wanted to sell 10 billion in Microsoft stock HFT will be willing to pick up quite a bit, but vary seen there will try and get rid of the stock and the net effect is they don't hold the stock for long enough to matter. Because, really what they do is time shifting not price discovery. Further the reason it works is buy and sell orders without attached prices which makes selling 1/10th of a second sooner cost you money.
I have no idea what you are talking about with "buy and sell orders without attached prices" (market orders?). You are correct that HFTs probably do not provide enough liquidity for Bill Gates to immediately liquidate his entire portfolio. So what?
Having only discreet crosses would not remove the value in lower latency for trading economic releases. There have been a variety of services (like Pipeline) that have services to facilitate large block trades. I fail to see how this would increase liquidity.
"A stable matching algorithm" is the real trick here.
Incidentally, the fundamental problem of zero sum behavior here is caused by the subpenny rule. Speed would be a non-issue if you were allowed to bid $10.031 in order to beat the faster guy who bid $10.03. Right now you can only bid $10.04, which is often too high.
http://www.chrisstucchio.com/blog/2012/hft_whats_broken.html
http://www.chrisstucchio.com/blog/2012/subpenny_rule_respons...
Easy. Assume all orders are limit orders, because non-limit orders don't need to exist. Perform the Gale-Shapely stable marriage algorithm http://www.cs.cmu.edu/afs/cs.cmu.edu/academic/class/15251-f1... Where the preference ordering of each person is assumed to be the order that maximizes their return. (The difference in the limit order prices.)
The actual situation is much simpler since all players have the same preference ordering, but this is just to show that it's easy to find one stable pairing.
The resolution issue on prices is not clear-cut. Liquidity is good, and I'm happy to have it. But infinite resolution (price, timing) trades do not per-se follow. And they ultimately, themselves, have a feedback loop. INstitutionalized front running (changing examples) is not benign liquidity, for example. Dynamic hedging would at least be a legitimate use, but absence its availability should be priced in accordingly in seperate markets.
In this case, it guarantees that no two people would rather trade with each other than with the person they actually traded with. In that sense, the stable pairing is pareto optimal.
Trade matching is not the stable marriage problem. Get a clue.
For example if you say, "a random trader gets to be the first proposer", then the firms with more money just flood it with trader entries, increasing the chance that they get to be first.
What about randomizing bids and asks, and matching them on a first-come, first-serve basis?
Let's say you had bids like this 10, 12, 9, 5; and asks like this 11, 12, 10. You randomize the the bids, and sort the asks. Then you do a linear search for the first ask that is <= to that bid, and that's an order. You remove the bid and ask from the lists, and repeat until bids and asks are removed. If there is no ask that is <= the bid, the bid gets popped.
http://www.chrisstucchio.com/blog/2012/hft_whats_broken.html
All it would take is for one major player to take a view on what was going to happen without hearing the fed data in an attempt to beat the market. Other algos then see that and act on it, playing the other players instead of the data, as algos are known to do frequently. All of this could happen in the time it takes for the actual data to get there.
There were tons of people who expected yesterday's announcement to turn out just as it did. I'm not saying that's what happened, just that it's a possibility to keep in mind before jumping to conclusions.
Still, skepticism is healthy, and it's possible that no scandal is involved.
Tapering was dependent on econ data, which simply hasn't been there to support it. I know plenty of people who were betting that it wouldn't happen, myself included. Good overview of why from before the announcement here:
http://www.moneyweb.co.za/moneyweb-safm-market-update/r-1805
But why would they wait then? "Guessing" or working with known public information is perfectly legal. They should act upon that data immediately. A leak is much more likely, as they would be afraid of an investigation when they "guessed right". They were almost certainly trying to trade as if there were no leak, but they forgot to add the slight delay.
If you actually had leaked information there's no reason you'd need to wait until the very last moment, that's when people who know nothing place their bets and their actions would be more likely to mess up your scam than cover up for it.
At which millisecond was the information "officially released"? Which of Bernanke's phonemes were decisive? Or do we know to the millisecond when the Fed's site was updated?
I suppose the coincidence between Chicago and New York is still a thing. Everyone receiving the leak agreed to fire at a particular time, and nobody jumped the gun?
A more 'science' way to make the claim that Nanex is making, would be to compare the same products on other Fed meeting dates.
A FAQ on the Richmond Fed's website [2] says that FOMC statements are released on the federalreserve.gov website [3] at 2:15 ET on the final day of each FOMC meeting. Unless there is an alternative statement provided elsewhere by the Fed, I assume that the FOMC statement is parsed by machines checking for differences in language use with the previous Fed statement -- doing a diff on successive FOMC statements is a common practice when reporting on a statement release [4].
[1]http://www.foxbusiness.com/markets/2011/09/21/copy-that-fed-...
[2]http://www.richmondfed.org/faqs/fomc/
[3]http://www.federalreserve.gov/monetarypolicy/fomccalendars.h...
[4]http://www.zerohedge.com/news/2013-09-18/fomc-shocker-no-tap...
Now, in another 50 years, I look forward to fingerprint analysis of a scale 1/1000th as fine: we caught you obeying the the speed of light, but you forgot to compensate for relativistic drift in X fashion. GUILTY!