Saturday, October 27, 2012

Banging the Beehive, Spoofing, and the Boston Zapper

Three years ago things like high frequency trading, flash orders, and dark pools were in the news. People with gigantic sums of money, large amounts of information (mostly legal), and very fast computers were manipulating the market. So what else is new? I wrote a post on the subject quoting the infamous con artist, Canada Bill Williams who said, “Yeah, the game is crooked but it is the only game in town.” Well high frequency trading is back in the news. These practices have exotic new names like, Banging the Beehive, Spoofing, and the Boston Zapper. These names sound a lot like the names of classic cons, the badger game, the fiddle game, and the wire game (made famous in the movie, The Sting).

But It’s the Only Game in Town
Although almost every article on this subject uses the name of all three methods for using high frequency trading algorithms (cons?), only one, Banging the Beehive, is explained in any detail. This sounds like theme and variation on the old (now illegal) pump and dump scheme. In pump and dump, a group of traders will release “insider information” on a thinly traded small company, usually in a tech sector, indicating that something wonderful is about to happen to this company; approval of a new drug, a patent is going to be issued, Amalgamated Monstero, A.G. is about to buy the company. Then the con artists begin to buy up shares. This causes the price to rise. The suckers buy in on the trend in the data, driving the price ever higher. At some point the con artists start selling their shares at a highly elevated price. Then everybody finds out the rumor, often published in newsletters, is false. Then the stock crashes back to its true value.

In Banging the Beehive computer programs will begin to flood the market with orders to buy or driving the price higher or sell driving the price lower. This in turn triggers automatic stop orders. Both institutions and individuals use stop orders to automatically protect them from wild swings in the market, but in this case it will cause them to loose a lot of money. In the flash crash of 2010, caused by high frequency trading, the Dow Jones Industrial Average dropped 9%! It then recovered in minutes, but the average investors protecting themselves with stop loss orders were massacred. The computers only need a fraction of a second and a price movement of pennies to make millions. Humans simply can’t react fast enough to survive in this kind of trading environment.

If you think you can time the market, I wish you luck.

Algorithmic trading is used for your benefit by your pension fund and your mutual funds. It has a place in the market. The problem is the quasi-legal actions of some schemers to gain a momentary advantage in the market can cause an awful lot of what the military terms, collateral damage. Regulators are always left playing catch-up, designing circuit breakers and changing regulations to stop the last catastrophe from happening again. Of course, the problem isn’t the last catastrophe. It is the next catastrophe.

No comments:

Post a Comment