Historically, fat finger trades -- where a trader presses the wrong key or adds a zero too many on an electronic trading system -- were considered exclusive to equities markets. Not anymore. They are now stretching their piggy little digits across into other asset classes.
Most recently, on June 8, an alleged fat finger wiped eight percent off of natural gas prices on NYMEX in an after-hours trade from Asia. The natural gas market recovered almost immediately, but not before some savvy traders saw what had happened and jumped in to buy and profit from the mistake, according to Reuters. The same thing happened during the May 6, 2010, equities flash crash, although it was the smarter machines with clever algorithms that did most of the jumping in, rather than human beings.
Fat fingers, abusive or manipulative trading and mini flash crashes, are increasing as high frequency trading penetrates alternative asset classes, such as energy and commodities, at a rapid pace. The Reuters article said that about a third of energy futures volume is now done by computers, and HFT accounts for half of that. Issues with high-speed algorithmic trading are growing concurrently.
Consider that on May 5 the crude oil market saw its second largest ever daily drop when sell-stops were triggered again and again by trading algorithms. This time there was no fat finger, and no Greek-tragedy style news such as that of May 6th, 2010. The $13 drop in the price of Brent was almost unprecedented, yet it made few headlines. Oil prices dropping are like equities prices rising - good news for most people.
But good news or not, the fall was exacerbated by several machines which had similar sell-stops programmed in. If a machine hits a sell-stop and the market plummets, it will likely encounter more sell-stops and push the market further down. This could cost investors a serious amount of money. If algorithms are not programmed to sniff out when they should stop selling, perhaps even to jump back in to buy, then money will be left on the table.
On May 5, human traders with charts could have predicted the fall, and some did -- just as they did during the later natural gas drop. There is nothing illegal about taking advantage of a sell-off, whether it is event-led or whether it is human or machine-created. There are concerns over whether human beings could trigger the sell-off intentionally, however. That is the domain of the already-overburdened regulators. But the velocity of the drop and the ungainly actions of the trading algorithms are my concern here.
As HFT-style algorithms migrate to asset classes with higher volatility, and oil is certainly a prime candidate, the margin for error increases. Fat fingers, market abuse or manipulative trading will trigger increasingly quick market moves. Many will happen before a human being can say "what the...?" and capitalize on them.
As we saw on the day of the flash crash, many algorithms sensed there was something wrong and pulled out of the market -- which decimated liquidity. While some of their owners were scratching their heads in puzzlement, some of the more clever algorithms recognized a buying opportunity. A report by four economists, "The Flash Crash: The Impact of High Frequency Trading on an Electronic Market," said that the buying activity of so-called "opportunistic" traders on May 6, 2010, could have translated into "substantial profits."
In markets that are relatively new to HFT, such as energy and commodities, issues with mini flash crashes, fat fingers and market abuse are just beginning. High frequency trading is still fraught with obstacles and issues, some of which cannot be regulated away. But out of some of these threats can arise opportunities for machines and algorithms that are flexible enough to face down and profit from the adversity.
Sooner or later (if not ongoing now) it will dawn on someone, that if you can execute a 'fat-finger' trade and cause a big shift in a market, that is an obvious ploy to use to make a killing in a market, if you have some friends to jump in and make the right buy/sell.
Through the years, we have seen numerous cases where someone will try to artificially move a market, so they can make a killing while it is distorted. This new capability makes it (a) infinitely easier, and (b) much more lucrative, so I would expect to see a LOT of it, until the systems are modified to prevent it.
So, not only can we have crashes from people accidently pushing the wrong keys, but crashes created to make money.
Now THAT prospect should keep regulators up at night!
Now they are rigged with explosives(!)
We can ban the gamed system.
It is a failure of technology and contrary to the notion of free and fair markets.
Having the fastest computer and gimmicky programmers is not the same as investment acumen or business savvy.
These traders provide no service we cannot do without. They are middlemen with dirty fingers in a pie they did not bake nor intend to eat. They do not even care that they are spoiling the pie for both the consumer and the baker.
They are killing investor trust in the markets while siphoning profits from those who incur the actual risk.
Profits from intentional or accidental mistakes is proof that their role is purely parasitic, even if it is technically legal.
It also calls into question how these nonproducers bought legislation to legalize their skimming con.
The markets should be properly regulated to prevent explosions, both accidental and intentional.
Would you fly on an airliner built in a regime of no safety requirements? That didn't have to meet some quality/functional standards?
Would you fly on an airliner that had never been tested in the air?
Why would we trust new trading schemes into the financial system without careful testing to determine whether they can crash the system, or without regulating them in a manner which guarantees that (a) they function safely in the target financial system, and (b) can't be abused?
I mean, the airliner may crash. A few people may die.
The financial system collapses and MILLIONS may die. Countries collapse. Wars ensue.
But hey, let's dream up a new scheme to sell derivatives, better yet, credit default swaps, and MAKE A LOT OF MONEY!!!!
We don't need to understand how they can interact with the system!
We don't need no stinkin' regulation!
People are flat, freaking crazy...