Red Knights, Killer Algos and Fat Tails
With Knight in total implosion mode, we would like to review a few good videos on antifragility, fat tails, the predictability of the unpredictable, flash crash and some up to date charts on the falling Red Knight.
Computers and algos are great, but you just need to have that big red stop button active. If one Algo can cause such harm, imagine having a few of those algos, operated by quant guys in their early twenties.
What could possibly go wrong?
Videos below.
Nassim Taleb
The Flash Crash reminder
And on the Knight subject by our friends at Nanex.
On August 1, 2012, starting at market open (9:30 EDT), our monitoring software alarms went off on hundreds of symbols. Looking closer at the data, we found many stocks had extremely high trade rates: several stocks sustained more than 100 trades per second.
We will continue updating this page with more details, be sure to refresh when visiting.
Updated 02-Aug-20120 7:05am EDT.
What Really Happened, or How to Test Your New Market Making Software and Avoid Detection and Losing a Pile of Money, Fast
What follows should strike you as crazy. If it doesn’t, read it again, because it is.
The following 3 charts plot non-ISO trades (regular trade condition) reported from NYSE in the stock of Exelon Corporation (symbol EXC). By plotting and connecting only regular trades from NYSE we get a clearer picture of the nature (some might say horror) of this event.
1. EXC One second interval chart. Circles are trades, the blue coloring is the NYSE bid and ask which is mostly covered by gray lines that connect the trades.
If we zoom in and look at what happens under one second, then a clear pattern emerges. We think it’s important to note that the SEC claimed there is no value to be gained from looking at data in time resolutions under a second “because it is just noise”. We strongly disagree.
2. A 25 millisecond interval chart that zooms into a 27 second period of the chart above. Now the gray lines connecting trades are more clearly visible. NYSE’s bid/ask is the blue shaded area (the bid price is the bottom of the shading, and the ask is the top).
The next 2 charts illustrate trades executions that ping-pong between hitting the ask and hitting the bid. As if someone is buying at the offer and then, almost immediately, selling at the bid, then buying at the offer, then selling at the bid and so forth. It turns out, the gray shading you see in charts above are the zig-zag lines connecting the alternating buy and sell executions. That’s right, almost all these trades alternate between buying at the offer and selling at the bid, which means losing the difference in price. In the case of EXC, that means losing about 15 cents on every pair of trades. Do that 40 times a second, 2400 times a minute, and you now have a system that’s very efficient at burning money.
Wall Street is very good at minting money. Burning money? Not for 30 minutes. More likely, for some of the stocks, such as EXC and NOK (shown below) the same firm was on both sides of each trade and were simply testing out new market making software. After all, the NYSE started their new Retail Liquidity Price Improvement Program the very same day, and only NYSE listed stocks were involved in this event. Also note that many of the trade executions are inside the bid/ask; something very unusual for trades and quotes from NYSE. Also, virtually all these trades are for 100 shares – the minimum number required to be reported in the system. And the timing of the trades is very evenly spaced, too evenly spaced. And many examples show a buy and sell appearing at virtually the same time, so close that the second trade has the very next exchange sequence number. Furthermore, the bid/ask spread remains very stable during this rapid buying and selling. Had these been real orders, the bid/ask spread would have quickly widened.
If this is true, then this firm would not have incurred any trading losses. They would have just ended up painting the tape. With a firehose.
This wouldn’t be the first time something like this happened. Maybe it will be the first time the SEC does something. Anything. But not likely.
3. Zooming in to a 1 millisecond interval chart, we can see one second of data which shows 39 trades.
4. A 25 millisecond interval chart of Nokia (NOK) showing the same pattern as above. Note: this chart shows bids and offers from NYSE as blue triangles instead of shading. There are so many trades that they appear as a coiling black mass. In Nokia, the trade rate was a steady 200 per second for many minutes.
List of affected symbols showing #Trades, Volume, and High, Low, Last data.
We snapped the top 500 stocks with the highest number of trades at 9:59:45 and then removed those that don’t appear to have been affected. For reference, we included SPY because it almost always has the highest number of trades. It is #52 in this list, which means an unprecedented 51 other stocks had more trades than SPY at 9:59:45.
The following 6 charts are 1 second interval charts of symbol VPU
1. Showing all trades color coded by reporting exchange.
2. Showing only ISO trades color coded by reporting exchange.
Trades with the ISO condition result from Intermarket Sweep Orders which can only be used by firms directly connected to exchanges. It is an indication of HFT
3. Excluding ISO trades. Note how nearly all of these trades are from NYSE-ARCA and are mostly 100 shares.
4. Showing best bids and offers color coded by exchange.
5. Showing all bids and offers color coded by exchange.
How to read Nanex Tick Charts