Fraud:
Deception carried out for the purpose of achieving personal gain
Insider
Trading: The buying or selling of a security by someone who has access to
material, nonpublic information about the security
Share wars: how the robots are robbing you
The prevalence of computer-generated trading in the modern sharemarket has created an unpredictable, and sometimes dangerous, environment for investors.
'The problem is that the computers queue-jump.'
Unlike a mere mortal trading, there isn't even a broker between machine and, well, machine. All that stands between them is a fee the Australian Stock Exchange collects.
Self-automated algorithms can generate 150 trades in the blink of an eye and, unlike ordinary investors or even the big funds, have been given the ultimate privilege of plugging straight into the ASX's computer. They're the ultimate inside traders.
Since the one-minute massacre of QBE Insurance more than two years ago by a rogue robotic trading program, all that has changed is that now it would take a mere millisecond. And it wouldn't stop at one stock.
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The share price was savaged from $15.70 to less than a cent before anybody could do anything.An even scarier incident recently on Wall Street, where price swings have become increasingly wilder, showed what the automated computer programs that drive most of its trading can do.
Knight Capital Group's computer went berserk, blowing $440 million in an hour and made a mockery of the prices of 150 stocks.
So entrenched has speed trading become on Wall Street and in most of Europe that, in this globalised world, Australia's regulators haven't so much gone along with it as only suddenly realised what's crept up on them.
In any case, the ASX is compromised because it let the computers into its data room in the first place, lured by the prospect of fees on tiny - but relentlessly frequent - trades.
SURVIVAL OF THE QUICKEST
Speed-trading computers sit next to an exchange's to minimise the millisecond it takes for data to go down a fibre cable. The whole point is they have to get in first.
The problem for punters who must use a broker, along with super funds and everybody else except the owners of the algorithms, is that the computers queue-jump.
They have an unnatural advantage in seeing an order before brokers do.
Think that's bad? Try this: ASX announcements and news wires such as Bloomberg are fed straight into the algorithms. They can read, digest and act on the information infinitely faster than you.
Bet you aren't sent a profit downgrade straight to your computer from the ASX the moment it's announced. Thought not.
But imagine the advantage a robo-trader would have in knowing before you.
That used to be called insider trading. Now it's ''liquidity enhancement'' and it's legit.
A variation on this is a tactic employed overseas, and possibly already tried here given the glitches the ASX system has periodically, which is swamping the exchange's computer with multiple single-share orders to slow down the system.
That can give the computers a few extra seconds to act, or jump ahead of any trades that had been frozen.
Often you'll see trades of a single share where the brokerage costs more than the stock. The computer is sussing out prices, forcing you to pay more - or get less if you're selling - than what your online broker's screen says.
Talk about unfair or, in finance speak, an uneven playing field. No wonder the corporate watchdog, the Australian Securities and Investments Commission (ASIC), is having doubts, except, like everybody else, it isn't too sure exactly what the computers are up to.
They can run rampant with a faulty algorithm until somebody pulls the plug, but not before the market has been shaken and confidence drained from it.
Either they're undercutting a seller or overbidding a buyer to get in first, beating you to the punch even at your price.
ROBO-TRICKS
Worse still is flooding the market with fake bids, suggesting something's happening and there's momentum, only to cancel them a nanosecond before the market opens. Once, that was considered market manipulation.
Regulators around the world have been duped by speed-trading proponents, invariably stating that it ''adds liquidity'', which aids what has come to be called ''price discovery''.
The true price of a stock is revealed because, thanks to the computers trading with each other, there are more trades and depth in the market.
Whether there's extra liquidity is debatable. It's not as if the sharemarket has unusually high turnover as we speak.
In fact there's very little, a worry in itself.
''Volumes are very low,'' says an equities analyst at Bell Direct, Julia Lee.
''Imagine what they'd be like without high-frequency trading.''
The trouble is that to escape the manipulative grasp of the computers, brokers are shifting away from the ASX into private exchanges known as dark pools because they aren't transparent. Speed trading has pushed up to 43 per cent of trades into them.
You have to laugh. The liquidity supposedly created by speed trading is drained into dark pools, leaving the official sharemarket no better and probably worse off.
As the GFC showed, liquidity is never around when you want it. And the robots run away first.
Even in normal times, speed traders put in multiple bids that are never executed.
One of the top-performing fund managers, John Abernethy of Clime Investment Management, will have none of it.
''What's price discovery? It's an invented term. It's just tripe,'' he says.
''High-frequency trading should be banned until the benefits can be proved. It can't be backed up with facts. From what I can see, it doesn't create liquidity, it destroys it.''
The price of a single share traded sure isn't going to tell you much. All it does is lift the cost of buying or selling shares.
''If you're not watching the market all day, you can put in an order for 10,000 shares and get just two, which we would never buy if that's what was on offer,'' Abernethy says.
Having inadvertently paid brokerage on a solitary share, you can hardly turn around and sell it, because you'd be out of pocket a second time.
''You end up paying more to get a decent parcel,'' Abernethy says.
Although the problem of automated trading is the gap between man and machine, ASIC's remedy, apart from talking about a circuit breaker, is to insert another computer into the equation. It would detect any tricks its robotic relatives were up to. Guess if you can't beat 'em, join 'em.
TIPS FOR HUMANS
So what can you do, short of avoiding the market altogether?
For starters, never submit an ''at market'' buy or sell order to your broker. You're playing right into the computer's hands - er, hard drive.
Otherwise you could end up with one worthless stock because you'd finish up out of pocket selling it.
Counter-intuitive as it sounds, also avoid mining stocks that have high turnover. Since computers get in first, you're only speculating against yourself. Speed trading can bash them around with no trouble at all.
And think twice about short-term trading. Robotic trading produces spikes or dips in prices that can easily be mistaken for the start of a trend.
To the extent speed traders dominate trading, a stock can stay fundamentally out of whack for a long time.
''They make the market much more volatile and unpredictable,'' says Dale Gillham, the chief analyst at fund manager Wealth Within, which runs the only accredited diploma of share trading and investment. ''It's like a marathon race. Someone sprints for 10 minutes and gets out in front but the pack catches up.''
The whole idea of speed trading is to catch you out, so the solution is to ''look at the bigger picture'', he says.
''Don't trade day by day. Look at the market on a monthly basis and say - what is the real trend?''
Another way of avoiding market manipulation is investing in an unlisted index or an exchange-traded fund.
These track the whole market, or part of it depending on the fund, and so whatever manipulation is going on should come out in the wash.
But don't hold me to it.
ROBOTS ON THE RAMPAGE
■In the Flash Crash, the US Dow Jones Industrial Average plunged 1000 points in 20 minutes, destabilising markets around the world. It quickly shoots back up.
■Shares of blue-chip QBE Insurance, a favourite of super funds, crash from $15.70 to less than 1¢ in about a minute. The trades are cancelled.
■More than 16.6million shares of FKP Property Group are traded at 40¢ each. The stock’s typical daily volume is only 2 million. The incident was captured on YouTube before it was reversed.
■Knight Capital Group in the US lost $440million when an automated trade went horribly wrong, sucking 150 stocks into the vortex.
■On Tuesday, there were four trades of one share in BC Iron at 11.16am at $2.65 each. At 11.20, the price surged to $4.64 in a nanosecond for no reason. Five minutes later, the ASX suspended trading for two minutes, then allowed the trades. The stock immediately dropped to $2.65.
SEVEN WAYS TO BEAT SPEEDTRADING
■Buy only quality stocks, and for the long-term.
■Track your order or you risk buying or selling just a single share or two.
■Avoid high-volume mining stocks.
■Consider lower-volume smaller stocks.
■Buy an index fund instead.
■Don't be fooled by big price swings in a day — they mean nothing any more.
■Dollar-cost average when buying to avoid price swings.
Volatility all the rage for fashionable managers
RATHER than avoiding the spills and thrills of the sharemarket, there's one way of embracing them.You can hitch a ride on the market volatility that automated computer-program trading generates.
While you need to avoid specific stocks, lest you find yourself on the wrong end of an algorithm, you can punt on the market bouncing up and down — which isn't exactly a tough call.
Fund manager van Eyk is so taken by the market's volatility that it's made it a separate investment, like gold or shares.
"This new fund treats volatility itself as an asset class," the van Eyk chief executive Mark Thomassays.
It uses options, which are volatile themselves, over the Chicago Board Options Exchange (CBOE) volatility index, but you have to invest at least $500,000.
For a more modest $25,000 you'll get into the Blueprint Alternatives Fund.
Unless you treat volatility as an end in itself, it's a "silent killer" of investment returns, he says, because "it reduces the power of compounding. The smoother the return stream from month to month and from year to year, the higher the final return."
The CBOE volatility index is also behind a series of warrants with a built-in stop-loss price sold by brokers RBS Morgan.
A major difference is these use futures contracts. They're also geared, which magnifies the risk, and so are strictly short-term investments.
Bet they'll show those robotic computers a thing or two, though.
http://www.smh.com.au/money/share-wars-how-the-robots-are-robbing-you
Trade market 'looking for boogeyman'
Broadcast: 19/08/2012
ALAN KOHLER, PRESENTER: Joining me this week are Marcus Padley from Paterson’s Securities, senior business columnist and the Sydney Morning Herald and The Age, Liz Knight and Tom Elliott, the chief investment officer at Beulah Capital.
And I forgot to say you’re the author of Marcus Today of course, Marcus.
MARCUS PADLEY, STOCKBROKER, PATERSONS AND MARCUS TODAY: Oh, thank you very much, Alan.
ALAN KOHLER: And – so what about all these dark pools and high frequency trading? I suppose it’s not surprising that the trading is down because it’s a bit of a scary place now, the stockmarket, for a lot of people when they look at all this stuff going on.
MARCUS PADLEY: Yeah. Volumes in the last six months I think have been the – in the last month, sorry, the lowest since 2005. There's a nasty trend. Volumes are well down and if high frequency trading is taking up a bit of that volume as well, it’s even worse for stockbrokers. I think Bell Financial just hit their year’s low. You know, the listed brokers are doing this. Plus they've got no corporate deals coming through. So it’s pretty rough market at the moment for most people in the industry.
But the dark pools and high frequency trading, I think he's right: there are two separate things. We were dark – we developed the first – or the broker I worked for developed the first dark pool 20 years ago in Australia, which was basically where institutions were upset at people seeing them moving on the screen and they would move prices, people would move prices against them just because they saw their orders on the screen. And so they set up a system where institution could throw their orders into basically an anonymous black box and they'd get matched up. And that's effectively what dark pools are. So of course the ASX is upset about it because it doesn't go through the ASX. And that's one area. And of course the high frequency traders, that's the sort of thing they're trying to avoid, which is people front-running their orders and making them pay more. And that's why the fund managers in particular are upset about high frequency trading, ‘cause effectively whatever money those guys make comes out of the price that an institution pays and a super fund pays and you pay and I pay and that money has to come from somewhere, and if it’s coming out of the price that we pay, which is a bit higher (inaudible).
ALAN KOHLER: What do you reckon, Tom?
TOM ELLIOTT, CIO, BEULAH CAPITAL: Well I think it's been forever thus. I mean, back in ‘87 people blamed the then stock market crash; I was on the trading floor here in Australia as a 19 year old on computers having gone mad, and here we are sort of 25 years later saying potentially the same thing. Look, I mean the fact is that whenever people aren't making money on the market, and now is one of those times, people always look for a bogey man. It was hedge funds during the financial crisis, computers back in ‘87, dark pools, high frequency trading now. The market is what it is. People find different ways of doing things. Front running used to occur back in the days of chalkies and traders on the floor. I don't think anything’s really changed apart from the technology that's used.
MARCUS PADLEY: But, Tom, having just to discard it all as perfectly fine, the point is how attractive is it for people to come to the market. The market needs integrity, people need to trust this. And this issue, which a lot of people don't understand, is an issue of trust and integrity. And in a market where people don't want to buy equities because they've gone down 40 per cent in five years, this just adds to the dissatisfaction.
ALAN KOHLER: What do you think, Liz? What do you think? You – do you trust the market?
LIZ KNIGHT, BUSINESS COLUMNIST, SMH AND THE AGE: I think it’s the inevitable rise of technology. And I think if we're going to do anything about it, it’s really gonna be the regulators that are gonna have to come in and do something about it. The ASX can bleat all it likes, but this is where it’s going. And as you say, dark pools have been around forever, just called something else. But high frequency trading is something that's obviously taking off. It’s gonna continue taking off until or unless somebody puts some sort of regulatory framework around it and of course now the regulators are getting their heads together to look at exactly that.
MARCUS PADLEY: The argument is it's already gone too far. It’s something like 60 per cent of trade in the US and you've got to stop it really early or ...
TOM ELLIOTT: Yeah, there's no stopping it.
LIZ KNIGHT: Well the cavalry does tend to come in a little late at times and – but I still think they will try and come in and rectify it to some extent.
MARCUS PADLEY: All they need to do is impose a tiny, weeny, little fee on every single trade, which may benefit some institutions more than others, and you’d kill the whole thing dead, as some exchanges have, and it doesn't exist in those exchanges.
TOM ELLIOTT: But that's just like a stock market version of the Tobin tax. Everybody says, “Let's stop the volatility in currency trading by having a tax on every trade.” Look, the thing about retail investors is it’s not fear of things – well it is fear of something that’s stopping them coming in, but it’s not dark pools or high frequency trading; it’s a bear market or at best a sideways market. If the market becomes bullish, I guarantee you all the self managed super funds will be out there buying shares, probably at the wrong end of it and they all get hideously depressed when the market’s going badly, and again, that has not changed.
MARCUS PADLEY: If brokers and fund managers were making a lot more money, they wouldn't give a ... flying flip about high frequency trading.
LIZ KNIGHT: A toss. No. Wouldn’t give a toss.
ALAN KOHLER: One thing everyone used to make money from was IPOs. There’s virtually no IPOs at the moment.
MARCUS PADLEY: Yeah, they’re down 39 per cent this year on a bad year last year.
ALAN KOHLER: And TRUenergy’s IPO was pulled. It was $3 billion. That was broken during the week.
LIZ KNIGHT: But until when? I mean, there’s been a lot of IPOs pulled and they're all waiting for the market to come back. One question’s exactly when the market is going to be sufficiently bullish enough for them to actually go in and see if they can make some money out of it.
ALAN KOHLER: Could be a while.
LIZ KNIGHT: Could be a long time.
TOM ELLIOTT: I must admit, I was surprised that TRU was pulled. I mean, the Australian market is in reasonable shape at the moment - not great, but reasonable. It’s not a private equity selldown, so it doesn't have that sort of smell hanging around it. And the share prices of Origin and so forth haven’t been too bad recently. I must admit I was surprised that the Hong Kong parent pulled the pin on Tru.
LIZ KNIGHT: Well I guess that's really what it says about how bad it is. If a good float that does have some prospect of doing reasonably well gets pulled, what’s it say for the others?
ALAN KOHLER: Yeah, they must have been very unhappy about that. I mean, because it was – that’s how they ...
MARCUS PADLEY: The timing would have been perfect. Infrastructure, utilities flying along ...
TOM ELLIOTT: Defensive. You know, it would have been really good.
LIZ KNIGHT: Yeah. Well that’s right. There's a long queue of private equity people trying to get rid of their assets via IPOs that just aren’t gonna (inaudible).
MARCUS PADLEY: They’ll be watching this program. It’ll be back on on Monday.
http://www.abc.net.au/insidebusiness
Trade parasites feeding at the heart of the ASX
Updated
In the Australian Securities Exchange's Sydney data room, which is about the size of a big lounge room, there are six "cuckoos". These are the banks of servers installed by high-frequency traders.
They sit against the wall opposite the ASX servers and each is connected directly into the host by a fat fibre optic pipe. Each cable is precisely the same length by agreement with the ASX so that none gets an advantage; if one server is closer to the input, its cable is looped around to lengthen it.Think about that: one less metre of optic fibre carrying data at 299.8 million metres per second - that is, the speed of light - would give one share trader an unfair advantage over the rest. It suggests that something pretty quick is going on.
The question is whether it's fair to the rest of us; whether those six parasites with their suckers fastened directly into the heart of the ASX should be allowed to get away with it.
The ASX is no longer a regulator, just a business, so it says that if the practice is legal and it pays a fee – not to mention a handy rent in the data room – then it can't and won't stop them.
For global regulators, it's actually too late: high-frequency trading accounts for as much as 70 per cent of the volume on American stock exchanges, including the NYSE; the time to control it was 10 years ago.
What do the computers and their algorithms do? Well, as my relatively low-frequency brain can understand it, these machines constantly monitor order flow into the ASX servers, and the sophisticated programs can pick up patterns that indicate when a reasonably large order has been placed. What they then do, in effect, is "front-run" – that is, they buy ahead of the order and make a small spread selling into it.
In other words, by operating at the speed of light they can "feel" a buy order coming and can dart in front of them and ensure that the buyers pay a little bit more than they were going to, without noticing a thing.
These operators begin each day owning no shares and end each day in the same position, but they make a lot of money by doing thousands of trades every day: it's a high-volume, low-margin business.
It's not known how much money the HFT traders make, but whatever it is, they weren't making it 10-15 years ago, and stock market returns have not gone up in that time, so whatever they make has come out of someone else's pocket.
That someone, of course, is you. The buy orders that the HFT operators are front running come from the superannuation funds in which ordinary people have their money. Now when they place an order, they usually end up paying a cent more than they would have because they are buying from someone who didn't own any of the shares 10 microseconds ago and only bought them to make that quick cent.
HFT represents less than 10 per cent of the volume of the ASX, but in the United States it is much more, and there is no reason to think we won't follow the US.
Should something be done to stop it? I think so, but it's too late.
HFT firms like the privately owned and aptly named Getco (Global Electronic Trading Company), the world's largest HFT operator, produce a large amount of self-justifying research material based around the proposition that they help investors by providing extra liquidity in the market.
This, plus presumably the hiring of expensive lobbyists, has snowed legislators and regulators and let the practice flourish, to the point where the parasites are taking over the host and it's too late to stop them.
Stock exchanges the world over are now making a fortune from renting space in their data rooms to high-frequency computerised traders and would probably collapse without it (the ASX would not – yet.)
As a result, investors are abandoning the "lit" markets and using "dark pools" instead. This simply refers to off-market share trading away from the official stock exchanges provided by investment banks where big investors know they are not being picked off by high-frequency front runners. The problem with that is that these "dark pools" are not properly regulated or transparent.
The joke is that in many cases, the same investment banks are doing both the high-frequency trading and running the dark pools; they are causing the problem and solving it, each for a handsome profit.
Alan Kohler is Editor in Chief of Eureka Report and Business Spectator, as well as host of Inside Business and finance presenter on ABC News. View his full profile here.
Getting the jump on high-frequency trading
Robert Gottliebsen
Published 7:20 AM, 18 Jul 2012
The legalised "insider trading" network, which now dominates share trading in Australian and American stock exchanges, has been caught dangerously extending its activities in New York. And the precedent is likely to apply in Australia.
I may be an optimist but I hope that the latest discovery of the activities of the “legal insiders” will be the first step in halting small American and Australian investors being ripped off by the big investment banks who are given exclusive entrance to legalised "insider trading".
Investment banks rely on stock markets to make their money yet their legal insider trading practices and the corporate governance requirements that came out of the Enron and other US crashes is substantially reducing the supply of new American listings. American companies now prefer to stay private. In the US the Facebook fiasco and in Australia the Myer share offer pricing is also making investors wary of floats where investment banks are involved, although in Australia the mining boom has masked the lower American listings trend.
The latest episode in legalised insider trading is revealed in the New York Times. The New York Stock Exchange (and the ASX) will vigorously dispute that they are fostering legalised insider trading. They call it high-frequency trading. In essence the big investment banks and others pay the New York, Australian and other stock exchanges big money to get a pipe directly into the trading system. Via this pipe they can detect big buying or selling orders as they arrive, enabling them to jump in first and make a killing by making the buyers pay more or the sellers get a lower price.
As Alan Kohler explained (High-frequency trading is cuckoo, April 11), there are six of these pipes into the Australian trading floor. There are many more in New York and from the New York Times report it would seem that some of those using these pipes are widening their sources of insider information from simple market trends to advanced knowledge of events.
In New York the market can move by large amounts after the CPI and other economic data is released. Prior to the release of the CPI the big news agencies are locked up so that when the data is released they have available immediate commentary interpreting the results. It’s a good system if not corrupted.
But this system appears to have been corrupted in the US on two fronts. First there has been leaking from the lockup and this is being addressed by tighter computer rules and systems. But the second corruption is harder to fix. Some of those in the lockup are reporting direct to those investment banks with a pipe. The investment banks therefore have the information just a little before anyone else. With their pipe direct into the exchange that’s all they need to make a killing.
A small media group has been banned from the lockup for doing this but wherever there is big money others will emerge and, now they see the rewards, the owners of these legalised insider trading pipes will seek to extend their advantage to other events affecting markets.
We have seen investment banks playing havoc in the US via sub-prime; in Europe via government bond raisings and now we are seeing further activities that reflect their profits at all costs mentality. Once these banks were important contributors to the capital raising system.
They still serve that function but some have added ruthless trading techniques to that activity.
Having a pipe into stock exchange trading so you can act faster than anyone else might be legal but it should be stopped. The stock exchanges are hooked on the money they raise from the investment banks and will not do it. The global regulators have it in the too hard basket and, at least in the US, the two major parties are dependent on the investment banks for their funding.
But the combination of the governance rules and the investment banks' bad market practices is slowly killing the goose. It will take time but eventually someone will wake up in New York and then we will follow. Or is it possible we could wake up first? - Getting the jump on high-frequency trading
Why High Frequency Trading is Cheating
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