Nanex came out with their report of a report on futures, lets call it a derivative. The original report is here, I only skimmed it but came away with harmless conclusions and nothing that a trader would not do themselves. I want to say that I am not a HFT apologist but I will let you decide. At the end of the day all market participants care about the health of the market, this is our livelihood. If there is a problem it is best to catch it early and Nanex will be on the for front of that discovery.
Lets set some ground rules for this discussion and move from there. Stocks are different than futures. Here are a few things that make it different.
- Futures are executed at a central place. Yes there are block orders but it is all reported. Unlike stocks which do not have to take place on an exchange. Supply and demand is what it is, this will become important later in the discussion.
- There are no rebates. The people who buy and sell with the intention of making money or discovering price. The exception is the CME Group does have a wholly owned subsidiary that is a market maker. As far as I know it is only used on the launch of new products.
- Commission structure. The exchange takes money from each trade. For the E-mini specifically it ranges from .095 to 1.16 each side so .19 cents to 2.32 a round turn. Plus clearing, NFA, and execution costs which vary.
Nanex ~ 12-Mar-2013 ~ Exploratory Trading in the eMini
If I had information that was “astounding” I would cross my T’s and dot my I’s. Maybe just do a bing search to see if I was spelling the main word correctly. For the record it is spelled E-mini.
Exploratory trading is a form of manipulation designed to test the market’s reaction to a trade. Probing for stop orders would be one form of exploratory trading.
If you have ever spent time in the pit, one of the more hilarious things is to see traders go John McEnroe on the pit recorder. Buying or selling a 1 lot on the highs or lows to get it to print and the recorder not seeing it and the pit turns on them. I have also seen traders do this on the screen. Sell a couple hundred to see what is there. Is it manipulation, if they did it with no risk I would say yes but they paid to see what was there and everyone can see what they are doing.
Another thing, if you aren’t testing the waters with a trade you are eventually going to run out of money. There are so many things that go into a successful trade and sometimes you have to be in it to see them all. There is important information that can be learned in how a fill happens. It is nice to know that they at least consulted a trader in building the algo.
Exploratory trading distorts the market’s view of supply and demand and induces trading activity from other participants.
I honestly have no idea what they mean by this. I have read this over and over. Futures are a contract. It is tomorrow’s price today. Hedgers pay to lock in costs. They don’t like the price at the time, they wait. If 1 trader does not decide to trade today it distorts supply and demand.
Furthermore, as participants learn of the strategy, they will employ counter-measures – which will further muddy an accurate picture of supply and demand for everyone else.
Once again futures are a derivative, it is its own market. Although almost all prices do trade but there are different quantities at each price. If someone sells 10000 E-mini’s it might move price 10 handles or not at all. Where else are you going to control $750 million notionally at a few prices?
Passive market making involves buying at the bid, and selling at the ask, which earns the market maker the bid/ask spread. Passive market making provides liquidity, narrows spreads, and lowers trading costs. Aggressive trading removes liquidity: buying at the ask (removes sell orders) and selling at the bid (removes buy orders).
Once again, algos with the exception of CME’s wholly owned subsidiary, do not provide liquidity. They do it for profit and have expenses and risk. Every trade removes liquidity, if you want to call it that. New buys or sells can immediately show up because of that removal of liquidity. I have seen the market go offer and not trade or go bid and not trade. Once all of the orders are matched you still need someone to hit the bid or lift the offer.
These 30 HFT accounts:
- participated in 46.7% of total trading volume.
- grossed $1.51 million per trading day.
Of these 30 HFT, the top 8:
were aggressive 59.2% by volume (the other 22 were aggressive 35.9% by volume).
grossed $793,342 per trading day.
Let’s assume the data is correct and there is a way to tell the difference between the activity. I do not know how they could tell the intention of each trade. I am not sure why they broke down the data in this way. Except to prove the point in the next paragraph. If I have compelling evidence I make it as simple as process and not raise any flags. Why aren’t their more HFT’s and why is the profitability skewed? Why aren’t the passive HFT more successful, the trade is at a breakeven instead of a gross $12.50 hole? My guess is because if you get a bunch you better really want them because you need another contract to get out.
A lot of media discussion about HFT focuses on 3 benefits: they provide liquidity, narrow spreads and lower trading costs. This Harvard paper exposes some disturbing truths: the top HFT engage in a predatory market manipulation strategy that removes liquidity 59.2% of the time (by volume), causes undue intraday volatility (which amounts to a tax on investors), warps the true picture of supply and demand, and raises trading costs for everyone processing market data.
Once again, HFT needs to be explored. I am glad that research is being done but the conclusions were not compelling, many the actual report is. HFT in futures provide price discovery not liquidity but in order to profit they have to get out. The E-mini market has a different purpose, rules, and different participants. Running the numbers quick in my head (about 750k e-minis a day/$1.5 million they grossed .50 cents a trade and without overhead it costs them .19 to cme, lets assume .04 in clearing and .04 to NFA.) they netted .23 a trade. Who is to say someone else would not be there if the algo wasn’t? Straw man argument, I know but something to think about.
CORRECTION: So I did bad math should have been $2 instead of $.50 and numbers work out better and closer to $1.77 a trade.
Quote stuffing algos are ridiculous and should be banned yesterday but they aren’t in futures. There has always been a mechanism of arbitrage. There are people who only arb between the months for rollover. There are people who arb the the pit traded contract to the E-mini. There are people who only hedge or trade spreads. These are all things that can distort supply and demand as Nanex defines. This isn’t the cash market. Every person who trades a future takes risk. The mechanical advantages aren’t as obvious as they are with stocks. I guess it is different if a person does it instead of a computer.
I have nothing against Nanex, they are a Chicago based company and I will never knock an entrepreneur. I know they care about what they are doing and have small dedicated team who works their asses off. I have a lot of respect for them however get the data and then decide don’t make the data say what you want it to say. They have said other things that were not exactly accurate about futures before and I was quiet but I saw a lot of people who I assumed were smart retweet the link. No offense to the media but linking to them does not add credibility to Nanex’s story story. They are always going to skew the conversation to fear and how things are not fair.
Once again, I hope this was read in an informative tone and not a sarcastic, hostel one. As someone who cares about the health of the market I am glad there are firms like Nanex. There are some bad things that happen with algos or fat fingers or technology or weather. Algos know where the big orders are and do take it the other way but so does anyone who has Market Delta. If the market moved in a logical way no one who make money or be able to lock in prices. With great amounts of data comes great responsibility.
Nanex if you are reading this will you do some research on volume per price from 1988 to today, broken down by percentage moves. I think that would be interesting if you want to see what algos really do to volatility and liquidity.
Sorry about the length I wrote this in a short period of time.
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