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At the CFTC's first Technology Advisory Council meeting on July 14,
there was concern expressed around the concept of quote-stuffing. There was
some evidence presented that the May 6th flash crash may have been caused by or
exacerbated by this activity. While with regard to the flashcrash, other market
experts I’ve spoken to know dispute this was the cause, quote-stuffing is a
topic worthy of discussion
At the CFTC meeting, where I was an invited participant, data was
presented from trade database development firm Nanex, which suggested quote
stuffing contributed to the destabilization on May 6th. In this case
the data suggests huge numbers of quotes were fired into the market on
particular symbols (as many as 5000 per second) and that many of these were
outside the national best bid/offer (NBBO). So what’s the point of this? Well
with latency as a key weapon, one possibility is that the generating traders
can ignore these quotes while the rest of the market has to process and respond
to them – giving an advantage to the initiator. Even more cynically one can
consider these quotes misleading or even destabilizing the market. In fact,
Nanex state in their paper: "What we discovered was a manipulative device
with destabilizing effect". Quote stuffing may be innocent or an honest
mistake, but Nanex's graphs tell a very interesting tale (http://www.nanex.net/FlashCrash/CCircleDay.html).
There are patterns detected - on a regular basis - that one could conclude is
quote stuffing for the purpose of market manipulation. There's a very good article by Alexis Madrigal that discusses the research and issues in more detail (http://www.theatlantic.com/science/archive/2010/08/market-data-firm-spots-the-tracks-of-bizarre-robot-traders/60829/).
At the extreme, quote-stuffing could operate like a “denial of
service attack” – firing so many orders that the market can’t cope - and
crippling the trading of certain symbols, certain exchanges or the whole
market. An influx of orders in sudden bursts to one exchange on one stock can
slow down that system as it tries to process these orders. Nanex notes that
there are 4,000 stocks listed on the NYSE and nine other reporting exchanges in
the U.S. If each reporting exchange for each stock quoted at 5,000 quotes per
second it would equal 180.0 million quotes per second. A daunting task no
matter how advanced their processing technology is.
Without trying to overstate the issue, in the most extreme
circumstances these practices could be considered algorithmic terrorism. One
can imagine how, at the extreme, it is potentially catastrophic. The concern is
that a well-funded terrorist organization might use such tactics in the future
to manipulate or cripple the market. So much of our economy is underpinned by
electronic trading – so protecting the market is more important than guarding
Fort Knox! Regulators, such as the CFTC and SEC are taking this seriously - and
need to respond.
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