I have tried my best to keep my frustrations to myself over the course of the past week but it has simply become too much. Before the super terrific congressional blue ribbon panel starts to impose all sorts of rules on the trading of securities, I thought it would be helpful if I cleared some things up about the “flash crash” and the number of things people are blaming it on.
The straw that broke the camel’s back as far as my patience was concerned is this nugget from an anonymous NYSE floor trader http://bit.ly/cIJKTg. I have a host of problems with this drivel. First and foremost, to those of you who have never ventured onto the NYSE floor and my have some delusions of grandeur from seeing CEO’s ring opening bells or old videos of traders singing ‘Wait till the sun shines, Nellie’, I am sorry to ruin your fantasy but it is a goddamn graveyard down there. I went on a prep school field trip and was simply amazed by how many people continue to grasp at it like it is a viable way to make a living, and that was ten years ago. I was also on the Boston Stock Exchange a few weeks before they closed down and it is clear that is not the way to trade. To paraphrase Danny Devito’s speech from ‘Other People’s Money’ I am sure this guy makes the best goddamn buggy whip you ever saw, but this business is dead.’ There should be zero floor traders anywhere. Next up, there was by no means a “wiping out $1 trillion in wealth” in a matter of minutes. Fluctuations in price do not wipe anything out, especially when they rebound almost instaneously. If that is going to be a point of contention then there should never be any selling of securities ever. Markets are not established to go up ad infinitum, they are to exchange securities at prices that counterparties see fit. David Weidner, resident asshat at the WSJ, felt the need to reprint people blaming it on the shadow banking system. Since clearly he and whomever raised that point have no idea what that means I highly recommend they read Paul McCulley’s latest GCB piece out of PIMCO. He invented the term and it has absolutely nothing to do with brokerages pricing equities. Please, do some level of homework before you start spewing of conspiracy theories about market structure.
I could try to explain to you what did happen and contrary to what you may be reading today it was not all because of some mystery trader at Waddell & Reed. However a far better run down of the entire thing has already been covered. Barry Ritholtz posted the play by play from another young institutional analyst. Although we differ on the true problem here, he gives a very clear view of how things transpired last Thursday. “So what happened here? Three things:
1. Sellers probably had orders in algorithms – percentage-of-volume strategies most likely, maybe VWAP – and could not cancel, could not “get an out.” These sellers could be really “quanty” types, or high freqs, or they could be vanilla buy side accounts. It really doesn’t matter. The issue here is that the trader did not anticipate such a sharp price move and did not put a limit on the order. The fact that the technology may have failed does not mean the
trader deserves a do-over, it means that the trader and the broker who provided the algorithm need to decide whether any losses should be split.
2. Sell stop orders were triggered which forced market sell orders into an already well offered market.
3. While the market was well offered, it was not well bid. Liquidity disappeared. For example, in P&G, 200 shares traded at $44.10 at 2:51:04 in the afternoon and one second later, at 2:51:05, three hundred shares traded at $47.08. That’s a three dollar jump in one second. Bids disappeared, spreads blew out, and no one was trading except a handful of orphaned algo orders, stop sell orders, and maybe a few opportunists who had loaded up the order book with low ball bids (“just in case”). High frequency accounts and electronic market makers were, by all accounts, nowhere to be found.”
for his entire piece (which I advise any and all to read) here it is at Barry’s blog http://bit.ly/dDpeSB
I keep hearing how terrible this event was, and if nothing is changed it could happen again. Oh no, what ever shall we do?! Here’s a thought, if you think the price of a security is too low and you think it’s insane that it doesn’t seem to have a bid, you should just go ahead and bid. That’s it. If the price is too low, pay it and make money. Only one group of people on earth that should be upset about what happened last week are PM’s like Tony Welch that the WSJ looked at earlier this week http://bit.ly/bc8fQh. They are guys who saw what they thought to be a price irregularity and pounced on it, only to get their trade cancelled for no reason whatsoever by people making up rules ex post facto. Especially when another PM that sits within spitting distance of his desk gets his fill cleared because he was a minute later and didn’t get as good of a price. I know a lot of people are under the impression that “regular investors” could be hurt by drastic market moves like this, but since the overwhelming majority of that buy side money is with large institutions guess what, they are all trading electronically with algos too, because it is the best way to do things. It’s faster, it’s cheaper, and most of all it helps these bohemouths keep from showing their side and getting front run all day. If somebody decides to put market orders out there they need to understand what they are doing and live with the consequences of that. It only hinders markets to do things like implement circuit breakers or time stops to let people that are too slow to catch up and adjust accordingly. It could easily lead to the sort of problems that are often seen in commodity markets where nothing trades for days or weeks on end because these measures get triggered immediately and the markets force zero liquidity on the day in the name of orderly price movement. Prices do not and should not move in any orderly fashion, they should move however the fuck they see fit.
What happened last week was simply markets correctly repricing risk during a day which had a whole host of unfavorable variables. In doubt? I recommend you take a look at LIBOR-OIS over the past two weeks.Risk was simply becoming more expensive. If you don’t want to be a part of that don’t trade on electronic exchanges. It had no ill effects on long term investors. It may have hurt the PnL on a few intraday traders but I must reiterate that is the only way exchanges work. They are prone to drastic swings when new information enters and that is a good thing. If anyone believes they have a better idea of how something should be priced they should simply participate and make money off of their knowledge.
That said, happy hunting out there.