This came across my desk the other day. It’s a standard release from an exchange to its members. In this case, it happens to be CME ($CME), but it could be any US exchange($NYX, $NDAQ, $ICE). This is part of the function exchanges actively perform. Self Regulatory Organization, or SRO. I have deleted the names and the amount of the fine to protect the identity of the person.
Q. commit an act which is detrimental to the interest or welfare of the Exchange or to engage in any conduct which tends to impair the dignity or good name of the Exchange.
T. to engage in dishonorable or uncommercial conduct.
Pursuant to an offer of settlement in which person, a non-member proprietary trader working for a member firm and subject to the jurisdiction of the Chicago Mercantile Exchange (“CME”) pursuant to CME Rule 400, neither admitted nor denied the findings and conclusions herein, on XXX XX, 20XX, a Panel of the CME Business Conduct Committee (the “Panel”) found that from XXX 1, 20XX through XXX 31, 20XX, Person traded index futures, including E-mini NASDAQ 100 Index futures contracts (“Mini -Nasdaq”) over the CME Globex (“Globex”) electronic trading platform. During this period, the Panel found that Person entered into a trading strategy that misled other market participants, including algorithmic trading strategies employed by other firms, and exploited that deception for Person’s benefit.
The Panel specifically found that during the subject timeframe, Person entered into Globex over 3,000 “large” orders consisting of XXX to XXXX Mini-Nasdaq contracts without the intent to trade those orders. When doing so Person typically began the trading day flat in his account and thereafter established a long (short) position by rapidly entering a number of aggressive one-lot orders. Once Person established his long (short) position he then layered the sell (buy) side of the book at various price levels that, if traded, would have completely liquidated his previously established position at a profit. The Panel found that immediately after completing the entry of his liquidating orders, Person then entered numerous “large” buy (sell) orders consisting of XXX – XXXX contracts on the same side of the market as his already established long (short) position to induce other market participants to trade.
I am only reading the outcome, and don’t have the benefit of the actual testimony. The fine was in the high five figures, and the trader was prohibited from trading for an extended period of time.
What I wonder is what is the difference between this and what HFT firms do every day? When I enter a big order on GLOBEX, or any other system, immediately an automatic trading system puts a one lot order in front of mine, and then sometimes races the market a bit higher to try and get me to move my order.
In some cases, I have put orders into markets and they spike significantly higher in seconds. That never happened in the open outcry days. We got prints that were out of line and later corrected, but we never saw the front running that we see today.
There was peer pressure inside the pit. A good order filler would vigorously defend their customer if they caught someone front running. Other traders would write you up and you would have to appear before a committee of your peers if it happened consistently.
In the above case, the trader had orders on the book. What would happen if a big program swept the book, and took out all their orders? They would be on the hook for quite a bit of risk. That could be a problem with his clearing firm if he didn’t have enough cash to cover the position, or enter orders that large.
One of the problems individual traders encounter is the allocation algorithm exchanges utilize to allocate trades. They are forced to put up huge amounts of size in order to get a few contracts when the price trades. Some firms like Trading Technologies are allowing traders to program their orders so that when they get what they want, the balance of the order is automatically killed.
HFT firms engage in all kinds of behavior that would be punished if they were an open outcry trader. They use flash orders, quote stuffing, and front run the book. Because of co-location, they have less latency than the rest of the market. They see the order flow milliseconds before anyone else. Milliseconds mean billions.
Virtually every day, you can find a commodity market or a stock that has been manipulated by high tech trading. The flash crash wouldn’t have happened in the old days. We had breaks and rallies, and big moves but we didn’t have large percentage moves in seconds.
Exchanges need to catch up to the activity of the electronic traders. If they don’t, the market will continue to trade sometimes as an aberration. What’s really clear is that we can’t rely on government regulators to keep up. They can’t keep up with anything, let alone trading at the speed of light. Exchanges have an interest in offering up fair and transparent markets. It is proper to charge them with monitoring the activity.
Exchanges are looking the other way with HFT firms. One because they like the volume. Two because they don’t fully understand what is going on. Exchange employees rarely traded in a market so it’s tougher for them to recognize disparities when they happen.
When they fail, they need to be disciplined, and the door is opened to competition. In the new age, the exchange with the most transparent marketplace, and fairest market place will win.