Automated Trading - What do we make of the bots?

[Lizard]

I am interested in comments, explanations and enlightenment on the large scale automated trading that is increasingly visible across the markets - the bots.

Can they actually push prices around as many seem to think? Or are they just making money by being quicker off the mark than other momentum traders?

They seem to be disliked by many traditional market participants. Why? What problems are they causing? I'd be interested to know if experienced traders are finding life with the bots more difficult. And/or how they may have adapted to bot trading.

[STRAT]

Hi Liz,
Dont know much about em but a few thoughts spring to mind.

If there are enough of them all operating on Technical signals then surely they would reinforce traditional Technical turning points and increase the momentum of existing trends. I imagine they would be checked and adjusted on a regular basis but left alone could easily increase momentum to the point they could cause significant rises or falls.

Also, Ive watched them in action stalling rises and falls while going against overall market sentiment with continuous tiny buys or sells on the odd day here and there.


I reckon the day we let computers do the thinkin for us we will be in big trouble sooner or later

[Snow Leopard]

...I reckon the day we let computers do the thinkin for us we will be in big trouble sooner or later

To an ever increasing degree we already are.

And when they run smoothly life is good, when they fail they really fail.

[axion]

I don't think the automated trading has much impact on the likes of us tbh. We're looking to catch largish moves, they're (and by 'they' I'm meaning short-term, high-volume operations) tinkering around the edges. Looking for mis-pricings between a gazillion different markets. Things we couldn't hope to do ourselves.


They certainly could push around the prices if (for some reason) they wanted to. I remember reading that Steve Cohens hedge fund accounts for like 3 or 4% of all daily trading on the NYSE.

Why they're disliked? A couple of reasons off the top of my head: they're picking up profit where we are unable to--in short, jealousy. Another is that they make markets more efficient, which means less good opportunities for us lesser folk.

[Lizard]

Given how common it now is, I've found it surprisingly difficult to find any serious information on the subject. Here's one interesting paper I've found so far:
"Does Algorithmic Trading Improve Liquidity?" (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1100635)

In summary, the authors found:
Algorithmic trading narrows the spread between the stock’s bid and ask price.
It reduces adverse selection, which occurs when buyers and sellers make decisions based on a different set of information and results in both kinds of investors acting adversely based on the known, rather than the accurate, level of risk.
It reduces trade-related price discovery, meaning activity more truly reflects actual supply and demand.

And here's an interesting view from one of the same authors responding to the recent "flash crash" on the Dow:
Street Crash Exposes World of Stock Market Electronic Trading (http://quantumpranx.wordpress.com/2010/05/14/wall-street-crash-exposes-world-of-stock-market-electronic-trading/)


It is a scenario that proponents of algorithmic trading, like Hendershott, had thought improbable, until Thursday. ”What computers are particularly good at is processing the same information in the same ways and optimizing that very, very quickly,” he said. ”What they might not be so good at is dealing with some new situations that have never occurred before.”

[macduffy]

Not sure if this is the latest thread on the subject but here's an interesting article by Robert Gottliebsen. The comments too are worth reading.

http://www.businessspectator.com.au/bs.nsf/Article/legalised-insider-trading-investment-banks-and-flo-pd20120718-WASQK?opendocument&src=idp&emcontent_asx_financial-markets&utm_source=exact&utm_medium=email&utm_content=79514&utm_campaign=kgb&modapt=commentary

[Snow Leopard]

from Reuters (http://www.reuters.com/article/2012/07/20/us-stocks-hedging-options-idUSBRE86J1AX20120720) (via ASB Securities morning brief)

(Reuters) - A mysterious trading pattern noticed on Thursday in the shares of four blue-chip stocks was likely an experiment in the automated hedging of large options positions, an analyst at JPMorgan said.
Many investors on Thursday were puzzled by the price action of Coca Cola (KO.N (http://www.reuters.com/finance/stocks/overview?symbol=KO.N)), International Business Machines (IBM.N (http://www.reuters.com/finance/stocks/overview?symbol=IBM.N)), McDonald's Corp (MCD.N (http://www.reuters.com/finance/stocks/overview?symbol=MCD.N)) and Apple Inc (AAPL.O (http://www.reuters.com/finance/stocks/overview?symbol=AAPL.O)), said JPMorgan Securities derivatives strategist Marko Kolanovic.
The prices of the four stocks oscillated in an almost perfect pattern, going up and down at almost exactly the half-hour and full-hour marks, he said. The unusual price patterns started from 10 a.m. Eastern time.
"We believe that the price pattern of Coca Cola, IBM, McDonald's and Apple yesterday was caused by hedging of options by a computer algorithm," Kolanovic said in a report. "In other words, it was likely an experiment in automatically hedging large option positions with a time-weighted algorithm that has gone wrong for the hedger."
The unusual trading occurred a day before Friday's expiration of July options, and the four stocks held some of the largest expiring positions out of all S&P 500 stocks.
It appears that as expiration approached, the automated algorithm was attempting to hedge the large sensitivity of the options to the underlying share price without paying attention to what impact it had on those stocks.
"When traders hedge their long options positions (gamma), they buy and sell stock periodically, often causing it to trade in a narrower range around the option strike price," Kolanovic said. "If the amount of gamma that needs to be hedged is large, these flows can overwhelm the liquidity and create patterns similar to what we saw yesterday."
Kolanovic said a computer algorithm was most likely responsible for the trades as no rational trader would trade in such a predictable fashion and time accuracy to his own detriment.
"Moreover, it may be hard to find a reason for buying stocks for 30 minutes and then selling them back in eight apparently meaningless identical cycles," he said.

(Editing by Leslie Adler)

[macduffy]

More from Gottliebsen:

"A key executive of one of Australia’s largest retail stock brokers has blown the lid on what he calls the “market rigging” which is taking place on the Australian stock exchanges.

He was commenting on my article (Getting the jump on high-frequency trading, July 18).

Bell Potter’s managing director for its wholesale division, Charlie Aitken believes that the “market riggers” – the so-called high-frequency traders – are causing the community to lose faith in Australian and world stock markets.

Aitken believes that the high-frequency traders account for at least 75 per cent of Australian market turnovers. While nominally the HFT traders are mostly household names among institutional brokers, Aitken believes these brokers are acting for shadowy anonymous overseas traders.

Aitken says that it is a national scandal that 75 per cent of ASX turnover is being conducted by unknown people whose solvency is uncertain and who could cause an Australian market meltdown if they collapsed. Aiken says these unknown people are not only manipulating the market but are the main cause if the violent share price fluctuations. In turn these fluctuations are driving retail investors out of share markets.

Aitken says that the justification that the “market riggers” provide liquidity to the market was simply incorrect. They are merely taking cream off the market – it’s a form of “legalised scalping”.

Aitken believes that this “market rigging” is starving companies of capital and the huge fluctuations it creates means that rights issues can no longer be underwritten. Via Aitken an institution, which did not wish to be named, also contributed to the debate taking the Aitken allegations a step further.

The institution says: “High Frequency Trading (HFT) creates false and misleading markets by being both sides of a stock.

“HFT pull their bids and offers as soon as it becomes apparent which way the flow in moving. Not only do they pull their bids or offers but also transact more stock going the same direction as the perceived order to try and sell this stock back to the buyer a few cents higher. This exacerbates the price moves and increases market impact.

“This is an unacceptable ripping off of the Australian consumer, whose money we manage, so I will continue to move more and more of my orders away from the official market and into dark pools. (Off market transactions)

“By mid next year most institutional orders will be done off room (in dark pools) and the market will have even less price discovery power. Volatility will continue to increase over this time.

“ASX you have really lost sight of your mission and purpose in life, to provide orderly markets and not to be focussed on increasing turnover at the cost of destroying confidence in the very asset class that supports you.

“The ASX do not actually own any stocks, they merely run an auction every day to which investors and potential investors come to transact. While there is preferential treatment being given to one class of investor these other participants will stay away and the ASX will end up throwing a party to which nobody comes”, the institution says.

In Business Spectator conversation that followed my comments, those trying to defend what I had called “legalised insider trading” said that the brokers had paid for the privilege of having a pipe into the trading system and so were entitled to the benefits. In other words they paid for the ability to “rig the market” (Aitken’s words) and so they should be allowed to do it.

That’s probably the view of the regulators who are turning a blind eye to the to the legalised insider trading being conducted. Frankly I believe markets should be fair and no one should have a special preference even if they can afford to pay for it.

In my view this is one of the greatest scandals in Australian business but it’s also a world problem. If we took a stand against the legalised insider trading or “market rigging” we would be hailed around the world.

In London I discover there is a whole queue of private equity deals wanting to list but the London market is as bad as Australia so they can’t be floated. In New York the number of listed companies has slumped.

Australia needs to stand up against the legalised insider trading. In the short term it will mean turnovers and ASX profits will slump. Longer term if we rung a clean market we will attract capital from all around the world. "

[upside_umop]

I don't think this is a problem for the investor, more a problem for the trader.
In 10 years time, the market is efficient enough to realise a more true value.
As Warren Buffett said "People buy stocks thinking it's important they go up the next day...and it isn't."

[hal]

I don't think this is a problem for the investor, more a problem for the trader.
In 10 years time, the market is efficient enough to realise a more true value.
As Warren Buffett said "People buy stocks thinking it's important they go up the next day...and it isn't."

What if your super fund is trying to accumulate a stock but are being forced to pay a higher price for stock because these programs can see the orders coming in and make them bid higher. The same could happen with selling where the programs front run the orders and force the fund(or individual) to sell at a lower price.

Seems like scalping to me and i can't see why it should be allowed. I can't see how this is creating efficiency it is more like an extra cost which is paid to the people with the best program and fastest computer. No good at all for the companies on the market or investors.

I have read a few articles on this and it doesn't look good or fair so I hope it is banned.

[Stranger_Danger]

I don't think this is a problem for the investor, more a problem for the trader.
In 10 years time, the market is efficient enough to realise a more true value.
As Warren Buffett said "People buy stocks thinking it's important they go up the next day...and it isn't."

Arguably, the impact on the long term investor of any manipulation is greater, due to the impact of compounding.

Lets say you want to build a $1,000,000 position in a mid cap stock subject to manipulation.

Lets say you end up averaging 50 cents a share, and without the manipulation, it would have been 40 cents a share.

The company does really well for the long term investor and after a decade is $5 a share.

And the impact on the long term investor?

$2,500,000

The impact is hidden by the long term nature of the investment, and, lets face, the bloke won't be complaining because its a ten bagger, but if true manipulation is happening, and leads to higher prices being paid than would otherwise be the case, then it does add up and arguably hurts long term investors the most.

Compounding compounds anything it touches - including the impact of a subtle manipulation of market prices.

[upside_umop]

I think you're all taking a negative and worst case approach.

Do you think these bots are pushing up the price and keeping them there? Not if you believe they're trying to make a profit...if they're buying to offload at a profit then they will sell the shares again and thus price will be lowered.

Personally, I hate all these excuses by "investors" for their poor performance and finding excuses for their failures.

What about when stocks fall and get shorted and manipulated below their true intrinsic value? No body ever complains about this? If a stock is over priced from "bots" why not short it?

There's two sides to every coin...

[macduffy]

It seems to me that the biggest downside is the negative perception of market "morality" that bot trading contributes to, as if there weren't enough market rogues being unmasked on a regular basis! And when a senior broking executive has this to say:

"Bell Potter’s managing director for its wholesale division, Charlie Aitken believes that the “market riggers” – the so-called high-frequency traders – are causing the community to lose faith in Australian and world stock markets.

Aitken believes that the high-frequency traders account for at least 75 per cent of Australian market turnovers. While nominally the HFT traders are mostly household names among institutional brokers, Aitken believes these brokers are acting for shadowy anonymous overseas traders.

Aitken says that it is a national scandal that 75 per cent of ASX turnover is being conducted by unknown people whose solvency is uncertain and who could cause an Australian market meltdown if they collapsed. Aiken says these unknown people are not only manipulating the market but are the main cause if the violent share price fluctuations. In turn these fluctuations are driving retail investors out of share markets.

Aitken says that the justification that the “market riggers” provide liquidity to the market was simply incorrect. They are merely taking cream off the market – it’s a form of “legalised scalping”.

Aitken believes that this “market rigging” is starving companies of capital and the huge fluctuations it creates means that rights issues can no longer be underwritten."

...is it any wonder that the man in the street distrusts the market these days?

[upside_umop]

I read that article through asb morning brief the other morning.

Basically, he's saying smaller companies get starved of capital because investors are skittish with the volatility (and increased volatility from so called bots). I'd say this is partially true - the good companies manage to raise capital still (NWE, NSE, BRU) and bad ones don't (NAV, BBG, GFF). Usually you have to have a sound business case on a risk reward basis to raise capital - that's the whole idea of capital markets. I bet you if NSE / NWE end up have sub commercial options after their current drilling program, the investors will punish them trying to raise further capital with no sound business case.

I don't think this would have much of an effect on the long term investor as the sort of companies that get manipulated are usually 'speccie' at best and the long term investor (super funds) usually have a allocation clauses where they can't place too much funds into them.

See, no worries. Business as usual.

[STRAT]

as the sort of companies that get manipulated are usually 'speccie' at best

See, no worries. Business as usual.SXY has had a Bot infestation most of the year.

[upside_umop]

I don't think you can blame the bots on this one either, Strat.

Sxy was a billion dollar company and wanted to raise a heap of capital at a time when things were going pear shaped. So did Bpt. Both down a good whack. Then there's Stx, Icn...Ogy - I think it's just been the mood of the cooper...

It works the other way too, doesn't it? Ie on the way up? :D

[STRAT]

Hi Ooomop.
Im sure it works which ever way the bot owners choose. Was just wondering if you consider SXY a speccie at best.

What I have noticed is they appear to be very good at stalling breakouts ( in either direction )

How you been? Has life returned to some sort of normal down your way?

[whipit]

This is worth checking out, pretty cool animation.

http://www.technologyreview.com/view/428756/watch-high-speed-trading-bots-go-berserk/?ref=rss

[macduffy]

Thanks, whipit.

Not a pretty picture though as they increasingly influence (engulf?) those markets.

[Toulouse - Luzern]

This is worth checking out, pretty cool animation.

http://www.technologyreview.com/view/428756/watch-high-speed-trading-bots-go-berserk/?ref=rss

Good article.
Thanks
The graphic makes the change volumes clear.

[macduffy]

ASX expecting action to curb high-frequency tading.

http://www.smh.com.au/business/asx-chief-hopeful-of-solution-on-highfrequency-trading-20121014-27kwa.html