By Frank James

Officials of the U.S. financial markets, shaken up like millions of other individuals who found themselves staring at screens in horror during last week's nearly 1,000 point Dow Jones Industrial Average sell off, have agreed in principle to address differences between exchanges that appear to have contributed mightily to the problem.

Many knowledgeable critics of high-frequency trading have fingered the blindingly fast trades made possible by automated computer programs for losses of about $1 trillion by some estimates.

While not all the causes of last Thursday's meltdown are known, New York Stock Exchange officials, and some market experts, say the nosedive happened in part after the NYSE slowed trading for 60 to 90 seconds in certain stocks whose prices had begun to act weirdly, Procter & Gamble and Accenture, for instance.

The NYSE does this when there are too many sellers and not enough buyers in a certain stock.

But the other exchanges kept trading the shares like it was business as usual. The relative lack of buyers meant many of the prices the automated systems found were ever lower, sometimes ridiculously so (Accenture for a penny, anyone? It's trading Monday somewhere above $40.)

So, now with the fear of God even on Wall Street, exchange officials have agreed something needs to be done. It looks like what they've agreed in principle to, in a meeting during which the Securities and Exchange Commission rode herd, is to institute what are called "circuit breakers" at all the exchanges, not just the Big Board.

Here's an SEC statement:

This morning, SEC Chairman Mary Schapiro had a constructive meeting with the leaders of six exchanges -- the New York Stock Exchange, NASDAQ, BATS, Direct Edge, ISE and CBOE -- and the Financial Industry Regulatory Authority to discuss the causes of Thursday's market events, the potential contributing factors, and possible market reforms.
"As a first step, the parties agreed on a structural framework, to be refined over the next day, for strengthening circuit breakers and handling erroneous trades."

High-frequency traders are not only getting blamed for the running down the price of stocks. They're also getting criticized because some of them essentially shut down during last Thursday's madness, which meant less of what Wall Street types call liquidity but everybody else calls money in the financial markets. That drove prices down even further and faster, according to the experts.

An interesting post from the blog of Themis Trading (h/t Barry Ritholtz of The Big Picture blog) describes this problem:

The market melted down and "liquidity providers" quickly pulled all bids. According to today's Wall Street Journal, high frequency firm, Tradebot, closed down its computer systems completely, as did New Jersey's own Tradeworx, who was so critical of our silly market structure comments in their SEC comment letter. By the way, if you don't know who or what Tradebot is, it is the proprietary trading engine that used to be part of the BATS exchange. In fact the reason BATS was rolled out as an exchange to begin with was to lower costs and facilitate trades for Tradebot (Tradebot's 1251 NW Briarcliff Pkwy Kansas City address is next door to BATS's North Mulberry Drive address fyi). In the WSJ article Mr. Cummings said his Tradebot system was designed to stop trading when the market becomes too volatile, because he "doesn't want to compound the problem." Too bad he doesn't understand that that was and is the problem. To make matters worse, while some high frequency firms shut down yesterday and pulled their bids, as we warned they would do for over a year and a half, other high frequency firms turned from being liquidity providers to liquidity demanders, as they turned around and indiscriminately hit bids like Randolph and Mortimer Duke.
We are just plain outraged, and think every investor and market participant in the USA should share this outrage. They were sold a lie. How many times over the last year have we all heard that HFT liquidity was a blessing that lowered costs and helped investors, and that it would be there in stressful markets just like the market makers and specialists they replaced were there? How many times have you read in the big media that HFT helped the markets perform brilliantly during the global meltdown in 2008 and 2009? We said it before and we say it now. Lies.

categories: Business

3:26 - May 10, 2010