August 2012

The Whipping Post

By Adam Sussman, Partner & Director of Research I am often an apologist for our market structure. I believe in the efficiencies of electronic trading and competition. I have a deep affection for U.S. equity markets but perhaps this affection is a bit misplaced. My apprenticeship in equity trading was at Datek Online, where our mission was to bring retail investors the same type of cost structure and trading tools that were only available to institutional players. But like another famous claim of Mission Accomplished, we may have created as much danger as freedom. The events over the last two years and 2012 alone must force anyone with even the most basic level of skepticism to question the current state of U.S. equity markets. Our intermediaries are failing us. It is simply astounding that the type activity that occurred yesterday at the opening bell went on for minutes upon minutes without some real time intervention from regulators, exchanges or brokers. All I keep saying to cheer myself up is thank heavens it was just money. As an industry, it seems we are not collectively implementing measures that would effectively protect our public from this kind of egregious error. If limit up/down would have dampened the impact, then shame on us for moving at a snail's pace toward its reality. Single-stock circuit breakers do not kick in until well after the market open, wild swings that occur at the open do not trigger the halts. And ironically, the original expiration date for the single stock circuit breaker pilot program was Tuesday, July 31. A cancellation tax would not have done the trick, right? If anything we should have paid for those orders to be cancelled. Constraining dark pools is unlikely to have ameliorated the issues that occurred in the last few months. Market access? Nope.

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So what could we do to stop these issues? I shudder to think that algos would need to be submitted to some type of Safety Control Board and even then Im not convinced that would catch operational issues. In the past I have called for all participants to cool the internecine bickering because I felt that these squabbles amplified market issues unnecessarily. I humbly retract those sentiments. It would be interesting to find out what percentage of the trades done at some of the more egregious prices were executed by Knight. It seems some people are forgetting that there are hundreds of algos out there that may have joined in at those prices, thus compounding the issue. On the flip side, I am sure some trading systems pulled back, la flash crash, because they knew something was awry and that there was a strong possibility of trade breaks. In this instance, it is not the pigs that get slaughtered but the lambs.

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2012 The Tabb Group, LLC May not be reproduced by any means without express permission. All rights reserved.