Chris Pickles, BT’s Head of Industry Initiatives -Global Banking & Financial Markets recently commented at an industry round table on Big Data, “… market data is probably the biggest dump of data going into a bank’s dealing rooms.”

Yet Big Data extends well beyond infrastructure.  A more competitive trading environment, tighter spreads, thinner margins and a lower risk appetite results in quantitative traders exploring more cross asset trading models and cross asset hedging. The side effect of this is increasing demands for deep data over longer time periods across a multiplicity of markets; Equities, Futures, Options and of course cross-border currencies.

The challenge of this data dump is dealing with the vagaries of multiple data sources, mapping ticker symbols across a global universe, tying indices to their constituents, tick-level granularity, ingesting cancelations and corrections, inserting corporation action price and symbol changes and detecting (missing) gaps in history. Any and all of these factors are vital to the science of quantitative trade modeling.  Big Data is about linking disparate data sets under some common thread to tease out an intelligible answer, a diamond from a mountain of coal. It’s about finding the cross asset correlations or understanding how to best hedge a position to offset risk, these are the underpinnings for trade models and portfolio management.

It is vital to recognize that data volumes can quickly overwhelm the capacity to consume and the resulting problems are manifold.  On one hand is the technology, poorly designed or legacy systems can easily translate to spending inordinate amounts of time and resources processing data, outfitting new storage and scrambling to deploy new systems to meet the rising velocity. On the other is the demand placed on the human intellect. The ‘search and (alpha) discovery’ of Big Data is to artfully leverage the mathematical and statistical sciences in a timely manner.

Big data IT is about managing scale. With 4.55B contracts traded in 2011 the Options markets, volume and velocity place enormous demands on IT infrastructure. The need for Big Data technology capable to swallow in big gulps is evident to cope with the information flood as more and more firms engage in cross asset trading. Not just for consumption of Options strikes but with the underlying Equities and the Futures and Foreign Exchange markets as well, which at last count was the world’s largest and most liquid market with average daily turnover exceeding 4 trillion dollars. But data cannot be seen as just a tech issue.

Big Data is a daunting task placed on human capital. Finding useful information in oceans of data is an increasingly complex problem. Big data is about big analytics. There is a clear and present danger of the inherent wisdom being lost in the darkness and noise as data accumulates in floods. A clear thread has to be teased from the veritable sea of information, to focus, direct and ultimately give meaning to what has been amassed. Whether its research for discovery of new models or backtesting to prove profitability, the skill to recognize the influencers of market impact, its inherent volatility need to be factored in. The quest to devise smarter models is what analysis is for. Yet ultimately to make sense of the analysis, deciding what to prune and knowing what to embrace is crucial for enabling you to make timely business decisions. It’s a matter of survival in the fiercely competitive trading landscape.

Once again thanks for reading.
Louis Lovas

For an occasional opinion or commentary on technology in Capital Markets you can follow me on  twitter, here.

Trading volume for U.S. listed options totaled about 4.55 billion contracts in 2011 while OPRA’s message volume has been steadily increasing at an annual rate around 40%. To say that the options market is all about Big Data is like noting that Mount Everest is all about snow. It states the obvious but also the ominous. On a human scale, you cannot consume or make sense of what’s inside that avalanche of data without the right technology and analysis any more than you can climb to Everest’s peak without the right gear.  Big Data is the core, Big Data is the catalyst.

US equity options volume is expected to double over the next 12 months.  Increased demand is a big driver of growth but the expected acceleration is due to a number of factors. Two such drivers are the advent of new products and new venues such as the CBOE’s all-electronic C2 Options Exchange which saw a steady 18% year over year growth.

Another booming area is the CBOE’s short-expiration Weekly options products on more than 30 different classes of the most active stocks, indexes and ETFs. These products with rapidly changing deltas can move in the money with short notice causing their trade volume to spike dramatically. Volume on those Weekly’s accounted for up to 11% of their underlying index volume in the second half of 2011.

VIX-based options have also been a big hit, with a total of 8.5 million VIX options contracts traded in June. The CBOE SKEW Index measuring the S&P 500 out-of-the-money options spiked in early spring 2011 highlighting a greater demand for these outliers. And of course the increased growth is due to more and more strikes in all underlying assets.

The use and proliferation of options has seen explosive growth as a strategic investment tool for more sophisticated hedging, portfolio management and for additional leverage on the performance of the underlier.

The incredible growth of the options market is undeniable.  Today’s options market represents the quintessential example of Big Data in Finance. Big Data is a trendy new catch phrase in business today, but nailing down an exact definition proves to be rather elusive. This is likely because the term has largely been associated with loosely structured content, originating from web search companies and social media. For the financial industry, the need for reliability and accuracy is what distinguishes social Big Data from financial Big Data.

Gleaning meaningful value from unstructured and social content is to judge sentiment, the mood of the human psyche portraying an emotion from the voices of millions. Any one or group of data points in the analysis cannot necessarily be valued as accurate or inaccurate only the determinants in behaviors.  Any loss is of minor importance because analysis is looking for mood shifts on the order of a turning ocean liner. In fact, the science of social data involves not what to keep, but what to throw away.

In finance, data accuracy is vital to determining outcomes.  Asset prices cannot be inaccurate or missing and they must be adjusted for any corporate actions such as stock splits. The reliability of resulting analytics such as implied volatility, delta and gamma calculations for option strategies and portfolio re-balancing depend on them.

The infrastructure technology for the options market has also become specialized to cope with the fire hose volumes and very large capacity storage of Big Data.  As we see more volume and market data flow across the OPRA feeds, we can expect that additional flow will lead to greater message traffic entering the market place as orders and executions. The increased throughput will burden older technology in an attempt to handle the load. Firms will realize it is not simply a matter of buying new versions of old technology to keep up with the problems of throughput.

I’ve occasionally heard the comment that the open source platform Hadoop defines Big Data. To say that any technology defines Big Data is an obvious case of the tail wagging the dog.  It’s the demands around industry use cases that create and foster technological innovation. That’s what drove the creation of Hadoop. Hadoop is a nascent technology that resulted from the desire to obtain analytical value from the vast amount of social data. It is not optimal for the volumes and speeds of high frequency financial data.

For the algorithmic world, direct exchange feeds for Options are becoming more desirable for their depth of book and lower latency along with greater use of real-time analytics. Option premiums are manufactured from two main ingredients: intrinsic and time value and the measure of how much money we should make factoring in the implied volatility. The Weekly’s short-expiration implies option strategies can respond to news announcements such as an earnings report in a make or break fashion. The underliers reaction to the news can signal an immediate move to take a profit or stop a loss. Big Data analytics is a defining characteristic of options market data and the wealth of analysis far exceeds all other asset classes.

Big Data will become de facto terminology in the coming year. Understanding its definition for finance is vitally important since the explosive growth of the options market is likely to continue unabated.

Once again thanks for reading.
Louis Lovas

For an occasional opinion or commentary on technology in Capital Markets you can follow me on  twitter, here.

When a definition is elusive, more subjective in nature than objective should that not dictate more discretion and a rational approach to achieve a goal?  When the CFTC’s Scott O’Malia set out to define high frequency trading through a seven-part test, definition was not his objective but simply a means to an end.  That end was a lever to enable further regulatory action in the coming New Year.

Speaking of regulation, SIFMA recently published a year-end study, The Impact of HFT where they mention the difficulty in creating a clear-cut definition. HFT does not neatly fit into any one well-defined bucket, but like so much of trading belongs to an overall categorization. A style trading that… a) leverages computer technology, b) makes use of algorithmic market making, arbitrage and directional strategies, c) limits human intervention.   Numerous buy-side, sell-side and quant firms fit into this categorization.

SIFMA’s Impact study does a nice job of summarizing the year’s regulatory actions. All those actions were designed to reduce uncertainty and the resulting risk premium in the market. A rippling backlash we’re still feeling 18 months later from the flash crash.  Here are my ‘most important’ from last year and for the next year.

Most important regulatory action of the year:

The Market Access Rule.  A euphemism for the Naked Access ban, this rule broke the unfairness certain participants were able to achieve in bypassing Broker pre-trade risk validation.  Those extra few milliseconds (or even microseconds) meant an edge for quoting or capturing a trade. Besides the fairness implied by the ban, instituting this rule has had a number of positive side-effects; a) it minimizes the possibility of a rogue algo wreaking havoc.  Here’s a prediction for the New Year. There will be no billion dollar rogue algo, and any such rhetoric is journalistic sensationalism solely for the back pages of the New York Post. The Market Access Rule for Brokers, Exchange monitored risk checks and the multitude of watchful counterparties will prevent anything but minor Infinium Capital style skirmishes from occurring. The embarrassing public hand slap they received will ensure firms will beef up their own testing before deployment. Any additional proposed regulations for algos (i.e. controls and/or source code inspection) are unnecessary. b)  Increased adoption of hardware acceleration in trading infrastructure.  On one hand, the Market Access Rule has leveled the playing field so-to-speak. The requirement that all orders run through the same (regulatory-defined) series of risk checks eliminates the advantage of Naked Access. That was a benefit to both trading firms that could afford the privilege and for Brokers marketing an attractive option in an effort to garner additional client order flow.  Poof, that disappeared overnight.  Well aware of the consequences, Brokers have rushed to hardware acceleration for pre-trade risk checks engendering a new (regulation-ascribed) low-latency battleground. Witness the announcements from  Morgan Stanley,  Bank of America and Deutsche Bank earlier in the year.  We’re not done yet, more to come in 2012.

Biggest regulatory concerns moving into next year:

1) Increased transitory volatility. There is no denying the turbulent markets are whipping up a frenzy of finger pointing. Who or what is at fault? The tumult of the market volatility has been blamed on numerous scapegoats including HFT and the human emotional response to bad news from European sovereign debt to Washington political divisiveness.  One of the side effects of present day communication technology is our ability to react to news from around the global moments after events happen. Smart phones, social media and news-based algo strategies have only extended and exacerbated this phenomena.  Volatility is not likely to ebb in the coming year; whipsawing markets are to be the new norm. Managing them is the solution so they do not run out of control. The SEC proposed Limit Up/Limit down price collars will offer protection against extreme volatility through a 5 minute pause in trading contingent upon the market’s reaction to the up/down rule’s ability to stabilize contra-side liquidity.  This is a more complex definition of the existing single-stock circuit breakers, but likely an improvement that will mitigate larger volatility swings and will have a wider calming effect.

2) Defining Market Maker obligations. I suspect there are few things that create fear and loathing for regulators as much as the difficulty in solving obligations for liquidity provisioning.  Regulators have to eventually face this difficult issue. Avoidance which has been the order of the day for the past year is not a permanent choice. HF Traders and other liquidity provisioning firms have no market obligation other than to their own bottom line. A liquidity drought is the fuel that can ignite another flash crash. Incentive mechanisms similar to the exchange rebates or amicable regulations to keep these participants in market during stressed market conditions are long in coming. However, this is not an easy problem to solve with a good chance of backfiring. Firms could simply move to more regulation friendly markets in other parts of the globe. Resulting in thinner liquidity and creating the very drought-like conditions regulators want to avoid.

The FIA Principal Traders Group (PTG) recently posted a response to Mr. O’Malia’s HFT definition.  They took issue with nebulous terms; such as “high” and “numerous” as in the statement: “The submission of numerous orders …”. Similar to SIFMA’s argument, trying to objectively define a subjective category is arbitrary. Doing so will simply result in numerous exceptions to the rule once you apply test cases to determine the validity of the definition.  The PTG present a rational argument to take advantage of existing regulatory controls, put in practice proposed rules and leverage audit trail surveillance systems.

Both SIFMA and the PTG appeal to reason with an argument devoid of emotional rhetoric, presenting a rational approach to the task of conquering market uncertainty.

Once again thanks for reading.
Louis Lovas

For an occasional opinion or commentary on technology in Capital Markets you can follow me on  twitter, here.

This past week I attended the Quant Invest conference, a show targeting quantitative trading, risk management and regulation. I moderated a technology-focused panel with a distinguished cast from numerous quant trading firms.  In our conversation we explored the challenging choices those founders and managing partners faced on their road to success.

When it comes to a firm’s technology decisions there is always the overarching question… What do we buy vs. what do we build? How do we determine the cost benefit model of that decision?  In lightning fast markets with razor thin margins how do you prioritize a business strategy? Is it time to market, tooling for fast strategy development, a need for low-latency, global market connectivity, highly available and disaster recovery?  Looking at the entirety of the trade lifecycle from the tools to research new trading ideas all the way to post trade clearing there are so many moving parts that firms have to be extremely careful to keep their eye on the ball. You’re in the money business, not the software business. But this is not so easily recognized.

Reports from the Hedge Fund industry show an odd mix of statistics. On one hand the industry is booming, in the first quarter of 2011 and even back into 2010 there has been a sharp increase in the number of new fund start-up’s. Over 300 new funds opened their doors.  With so many layoffs from the big investment banks figuring out what many of those money managers decided to do next is not too difficult. Yet those same Hedge Fund stats reveal another trend, that in January thru March almost 200 funds closed down business.  As quick as a new fund opens another one dies on the vine. They are likely failing to achieve returns above the broader market, but is there also a hidden corollary?

The dynamics and scope of running a successful fund extend far beyond the prop trading desk at any bank.  There is a dual challenge to grapple with, managing the investment capital and the deployment of a wide range of automation technology to enable that success. Within a fund or prop shop there is no army of IT staff managing the pipes and trading infrastructure as found at those banks many left behind.

The increasing prevalence of automation and rapid-fire trading technologies has increased competition. Sophisticated algorithmic strategies have become the hunter and all else the hunted. Unfortunately the statistics bear-out that many firms are ill equipped to rise to the challenge.

Automation and the technology behind it play a critical role in the trade lifecycle. Its evolution goes hand-in-hand with innovations in trading. Knowing the right blend of build vs. buy is as big a key to success as the profitability of the deployed strategies.  Misguided development choices can often lead to costly overrun projects, leading you astray from the things that matter most, what drives alpha.

For those firms on my panel the dilemma of build vs. buy was put to the test. Most sought to achieve a fast time to market, leverage what they knew - that internal intellectual property (IP) and farm-out the rest goal. Strategy design and development in traditional languages such as C++ was the convention with vendors and brokers supplied the remaining functions; a) Tools for alpha discovery and quantitative research. b) EMS/OMS functionality c) Connectivity for market data/trade execution d) Services for post trade clearing and TCA.  One brave and daring quant fund however chose to build their entire trade platform in-house including their own custom TCP/IP stack.

Nonetheless, having a sound technology strategy is of critical importance. Knowing your priorities and defining a technology decision matrix will depend on what you aim to achieve, your trading style and internal core competencies.   In any case being smart about your technology decisions is a means to be smarter about your trading. Investing your intellectual property of human capital towards the primary goal of finding alpha can mean the difference between success and being a part of those failure statistics.

Once again thanks for reading.
Louis Lovas

For an occasional opinion or commentary on technology in Capital Markets you can follow me on  twitter, here.

Over the last 3,000 years there have been numerous inflection points that have set humankind on the steady march towards the liberties and freedom most of us take for granted. Chris and Ted Stewart, authors of The Miracle of Freedom wrote of seven historic tipping points, in each they saw the portent of a new age redefining and elevating individual liberties and justice. Those decisive events were plights that span victories in battle to the preservation of the collective intelligence from barbarous hordes, each one a stepping stone in the struggle against tyranny. One could debate that there certainly have been more than seven that shaped our present day sense of self-determination. Yet the author’s goal was not to describe all such cases, but to show how the conflicts precariously hung in the balance and succeeded only by a slim margin or a stroke of luck. And all too often the norm was tyranny and injustice and despots the ruling hand across most of the last three millennia.

Global regulators are once again under pressure to provide an explanation of the whipsaw volatility in the equity markets. There is growing vexation among traders and investors. The lack of confidence in the equity markets throughout much of 2011 can be seen in lower traded volumes. Regulators are looking to better understand the role played by high-frequency traders in the volatility. The U.S Congress and European parliaments have stepped in under political pressure and are looking to legislate through taxation. The proponents argue that it would slow down or eliminate high-frequency trading by wiping out their profit margins. The analyst firm Rosenblatt Securities estimates that HFT firms make about 1/20 of a penny per transaction. A 0.03% tax would destroy any chance of a profit, worse as Dennis Dick from Bright Trading describes it would hit quant-firms as well, those investing in technology and people and are not necessarily looking at ultra-low latency arb. Such legislation is a fool’s errand driven by the desire to find a convenient scapegoat.

Attempts to legislate presumed fairness will ultimately result in a loss of freedom for all. Scapegoating high-frequency trading will undoubtedly lead to more controls to the detriment of all market participants, exacerbating the vexations and market uncertainty regulators ultimately aim to end. Since the industrial revolution, segments of society have had an irrational fear of technology (i.e. luddites). Technological advancements have always been a double edged sword providing undeniable benefits for many and the end of a way of life for others.  Yet advances in trading styles have shown to have a positive impact. This is not to say, there are not a few bad actors. There have always been those focused on market manipulation long before the advent of high performance computer technology. But Black Monday didn’t lead to computers being banned and HFTs aren’t likely to go anywhere either despite political pressure to the contrary.

Regulators have to improve their understanding of market microstructures, the impact of algorithmic and high frequency trading in particular to introduce reasonable regulations. It’s been a year and a half since the well-publicized flash crash revealed the fragility of market structures. Since that time we have had restrictions (no more stub quotes) and price collars put in place to contain the outbreak of another one. There are countless academic papers on the subject as well. Yet one key contribution that could instill investor confidence is the deployment of the consolidated audit trail (CAT). Yet there appears to be little if any advancement towards that goal. Regulators seem to be ambivalent, or are they just proceeding cautiously?  Are they now distracted by the budgetary season as Congress looks for places to reduce deficits? Are the SEC and CFTC looking to safeguard
their base just when they should be ramping up on implementing reforms? The investment community wants definitive action. John Plender, mentions in a Financial Times article the need for a ‘regulatory verdict’ to once and for all determine if algo traders are manipulating prices creating toxic liquidity in the Lit Pools. Toxicity is not only in liquidity but in attitudes towards trading styles. The CAT could provide the needed granularity for surveilling and identifying market integrity issues. The scale and magnitude of the project is obvious, yet there is always that small first step.

Volatility is an irrational behavior; explanations for the whipsawing moves are levied on leveraged ETFs to fears over the European debt. The markets won’t accept irrational outcomes, such uncertainty creates a risk premium keeping the investment community sitting on the sidelines, as can be seen in the decrease in equity volumes and consequently contributing to a stalled economy. But the anxiety that manifests itself in the markets is really structural deficiencies in the overall economy and government divisiveness. The inaction and lack of leadership in Washington has resulted in a vilification of Wall Street. And that is not likely to end until the economy comes back. But we won’t see an economic turnaround until the courageous step forward to bridge the divide in Washington. As Thomas Friedman once said, leadership is hostage to its own ineptitude. A bread and circuses style of appeasement through legislative controls under the guise of fairness will continue to be proposed further tightening the reins.

In the book, The Miracle of Freedom, the authors conclude with a conversation about ‘this thing‘. Not something tangible, but a thought, a belief in something so precious to many but often overlooked by those born into it:

Once again thanks for reading.
Louis Lovas

For an occasional opinion or commentary on technology in Capital Markets you can follow me on  twitter, here.

The judging criterion for this award is to outline the essential characteristics, achievements and innovation that place the product ahead of the competition. OneTick is technology designed solely to serve the financial industry as an integrated solution, a single source for tick data management and analytics that spans the past, the present and future for historical and real-time marketdata. One that  stretches out across the well-known assets classes of equities, futures & options, commodities and currencies but also a platform that can dig deep into the esoteric; treasures, mortgaged backed securities and sovereign bonds just to name a few.

Financial data is the quintessential definition of Big Data. But without a doubt the most important aspect is accuracy. Mid-year, 2011 we launched the big data product OneQuantData. Leveraging the OneTick high performance database, OneQuantData is designed for trade modeling, beta indicators, mark-to-market calculations and numerous other use cases where the value of clean and accurate closing prices and reference data is imperative for quantitative research and portfolio management. Pushing the limits of creative innovation for real-time analytics, high performance capture & query and accurate reference data yields an award winning combination.

Recent predictions from industry groups are expecting U.S. equity options volume to double over the next 12 months.  The Options Market Reporting Authority otherwise known as OPRA has seen data volumes on a steady annual increase of nearly 40%, peaking at 1.5 million messages per second at year end 2010.  The advent of new Options products and new Exchanges such as Miami International Securities Exchange (MIAX) will push the boundaries of technology. It’s imperative for exchanges and trading firms, even retail venues such as Scottrade to partner with the right vendors like OneTick who have developed effective high-performing technology to handle the fire-hose of market data that is the Options market.

Focused on providing buy-side and sell-side customers with the best solutions to meet their high frequency & quantitative trading and risk management needs, OneTick provides a single solution that:

a) crosses all asset classes
b) is an encompassing technology platform for trade decision modeling and costing analysis blending historic and real-time prices and execution data
c) provides a fully integrated Big Data repository of accurate closing prices and reference data

OneMarketData provides customers with the tools, technology and data to leverage their own creative innovation and human capital.

Once again thanks for reading.
Louis Lovas

For an occasional opinion or commentary on technology in Capital Markets you can follow me on  twitter, here.

Scottrade Inc. a premiere on-line investment firm, retail brokerage and a household name in online trading has chosen OneTick the leading tick data management solution to power their award-winning trading platform. Scottrade offers online investing in stocks, options, mutual funds, IRAs, fixed income and a whole lot more.  Onetick’s high performance tick database and integrated Complex Event Processing (CEP) engine blend historical and real-time market data for maximum speed and functionality. Combined with a large library of high-precision time series analytics proving time and again why firms such as Scottrade chose OneTick.  The trading lifecyle begins and ends with data, that includes historical data, live market data and corporate action reference data.  With OneTick’s ability to capture, store, reference and analyze markets, firms can devote valuable time and resources to research and trading tasks and not processing and programming.   OneTick is a solution rooted in the blending of high-performance historical database and real-time Complex Event Processing. These two paradigms fused together provide the basis for next-generation quantative research and trade decision modeling.

Tis the season for racing and its Full Throttle with OneTick.  To learn more why Scottrade and other major firms like Tudor Investments, Société Générale, and countless brokers, investment banks, hedge funds, prop shops and market places have chosen OneTick. Download one of our many webinars, whitepapers or watch a short video introduction.

OneTick is an enterprise solution capable of capturing, storing and analysing market data across any asset class even the massive OPRA feed for conducting research, strategy backtesting, building trading solutions and conducting transaction costing and slippage analysis whether against individual instruments, indices or whole portfolios.

Once again thanks for reading.
Louis Lovas

For an occasional opinion or commentary on technology in Capital Market you can follow me on  twitter, here.

We are all made from stardust… Without the research begun centuries ago in mathematics, chemistry and astronomy we would not enjoy the benefits of modern medicine and advanced computer technology today.  Research has been the wellspring for modern society for which we simultaneously bear the burden and enjoy the benefits of what has come before.

Far too often in times of distress whether economic or in our markets contentious opinion tends to be the rule that sways.  Fueled by emotion a scapegoat is sought out to pin the burden of blame for whatever ails. The tumult of the recent market volatility has been blamed on numerous goats including HFT, Greek sovereign debt,  the short-sale circuit breaker and basic human (fickle) emotion. But hidden behind all that media cacophony is the quiet voice of reason.  In universities across the U.S. and Europe academic researchers are immersing themselves in analyzing our market structure.

University faculty and graduate students within financial engineering departments are engaged in a quest to understand the multitude of factors that influence our market behaviors, both its successes and failures. They look to move beyond the anecdotal to discover hard evidence. They seek to lay bare the empirical truth of what forces however subtle shape the yield curve, determine the microeconomic aftermath of macroeconomic policy decisions such as quantitative easing or the Fed’s Operation Twist to lower long-term rates.  What factors are driving market efficiency? Is there significant influence from the exchange maker/taker rebate schedule? Richard Holowczak Professor of Computer Information Systems at Baruch College, City University of New York looks to gain a deeper understanding of the Options Penny Pilot  which was begun a number of years ago but had a profound influence on the Options industry’s growth.

Analytical financial research looks for the determinate forces of market microstructure. The goal of which is to rationalize the interplay of those forces, the participants influence on price formation, price discovery and transaction costs.  Many research studies have lasered in on high-frequency trading and its impact on volume, spreads and market quality – specifically volatility and liquidity. That is a hot research topic as HFT has matured and the industry wrestles with coming to terms with the proliferation of electronic trading across all asset classes.

What of the market impact of recent regulations? There are trade halting rules like circuit breakers and limit up/limit down. New pre-trade risk controls in the Market Access rule and greater transparency imposed by the larger trader rule.  While it may be too soon to fully understand their fallout, research is underway to understand their reverberating effects not just within the fragmented equities markets, but also across the landscape of other assets classes. Understanding the consequences of regulatory changes is of vital importance to all participants.  How else would we know conclusively of a potential Butterfly effect?   Costis Maglaras, David and Lyn Silfen Professors of  Business at Columbia University, discussed how the study of modern market microstructure is interdisciplinary, combining elements from economics, finance, engineering and mathematics. Faculty members and students from across the University spanning different disciplines are actively involved in the study of today’s fragmented, stochastic and high-frequency markets pose interesting questions on market analysis, market design, trade execution, and policy.

University professors use research projects to challenge graduate students to understand market mechanics, explore and optimize trading behaviors, solve optimal execution problems and better understand modern portfolio theory. For this they have created mock trading floors and big data stores to house deep equity and options data. University faculty strive to educate and groom the next generation of quantitative analysts, economists, even future regulators and prepare them for eventual leadership roles in the financial marketplace. 

The quest for the truth is a noble and lofty goal. Author Sylvia Nasar says of John Maynard Keynes, a confidence in the “apparatus of the mind” is of utmost importance for wrestling with economic catastrophe.  The recent market volatility has caused far too many to wield anecdotal opinions and too few armed with evidential facts as to why we’re witnessing such distressing conditions.  While it has pressed the SEC to accelerate its efforts to deploy the consolidated audit trail (CAT), and will likely cause FINRA to revise its own order-audit trail system (OATS), universities across North America and Europe have been pressing ahead to reveal the truthful image.

In a recent interview with TABB Forum’s Gregory Crawford, we discussed this same topic of academic research.  You can watch that video (click on the image), or logon to TABB. In that video Greg and I explore these same ideas and concepts of market efficiency, it’s influencers and the importance of academic research to industry.

Once again thanks for reading.
Louis Lovas

For an occasional opinion or commentary on technology in Capital Markets you can follow me on  twitter, here.

To behave nobly and heroically in an obviously hopeless cause is a kind of folly, but it can also constitute a kind of greatness. Despite the wrongheadedness of the enterprise, an air of transcendence arises from their sufferings. It was in vain that they died, but their deaths raised them up, as it were, and made them emblems of whatever it is in human beings that can seem sublime.
- Anthony Brandt,The Man Who Ate His Boots. The Tragic History of the Search For the NorthWest Passage

For the better part of the 19th century the British Navy was on a quest, a relentless search for the Northwest Passage. It was an elusive goal to find a sea lane through the vast arctic ice across North America to the Pacific.  How can one not have a deep admiration for those brave souls who trekked out into the frozen unknown in search of a dubious goal for God, King and Empire?  They had nary a safety net that would be available to any such voyager today. No GPS, no GORE-TEX, none of the vitamin-rich packaged super foods and no helicopter rescue team. In hand nothing but their own wit, sheer determination and a bit of luck as they stared out over the vastness of endless ice with frostbitten fingers. Would they ever safely navigate its enduring bergs and shifting floes with sail, compass and the stars to guide them? Of course they never did, eventually giving up due to the exorbitant cost and too many brave souls lost, but certainly not for lack of courage, fearlessness or enduring effort. 

In the volatile days of August a steady rain of accusations fell. High frequency trading bore the brunt of abuse for the market’s irrational behavior from pundits and media alike. On any given day, one could find a wealth of articles with phrases or headlines such as:  fraught with hazard, operating in the shadows, seizing the best deals at the expense of ordinary traders,  we need to cage the cheetah’s, no redeeming social and/or economic value. The list of cold commentary is endless.  It makes me wonder when the hordes, pitchfork in hand will stampede yelling ‘Kill the Beast’. Such frosty behavior looks to celebrate a collective vengeance against HFT firms not seek justice for what ails. Many are intractably opposed to HFT, that HFT is bad for the markets has become endemic.  Art Cashin called the market’s steep drop “a classical technical breakdown” and said high frequency trading was contributing to the decline. Doug Kass rages against machines as “too fast and too stupid… humans are smart enough to avoid a massive selloff like we had… [machines] obviously don’t care about the fundamentals behind the numbers…“.  They would have us retrogress to a time when all trading was conducted by people sans machines. So what has fueled all this negative sentiment against HFT? As David Brooks highlights, behavior that seems altruistic is really self-interest in disguise. We’re bascially selfish creatures able to act altruistically only when we stand to gain.  August’s declines caused the market to lose billions in wealth while HFT firms racked up daily profits from $60m to $200m. It’s hard to ignore the creation of an ideological difference in attitude, fueled by losers who vehemently disagree to any notion of profiting from a losing market. But long term, no one wants that. It’s a losing proposition for all participants and the global economy.  

What is happening? A chilly reminder of increased regulatory control and oversight.  The result of the crusading commentators has pressed the SEC and FINRA to ask high-frequency trading firms to hand over the details of their trading strategies. This amounts to revealing their highly guarded intellectual property, something they are loath to do. I’m sure the HFT luddites are wringing their hands.  Yet armed with this information even from numerous firms, the regulators still face the difficult problem of determining market impact.  Can they extract the human element from market volatility in their analysis?  As Phil Pearlman describes “Periods of extreme price volatility have occurred for as long as there have been markets and they will continue to occur periodically as long as humans are involved“. And what about all those other emotional fears driving the markets?  The Dow Jones Industrial Average fell more than 400 points on the day when the Philly Fed survey for August was announced. Investors panicked. When H-P announced a management shake-up, lowered its outlook and dumped the Touchpad, the stock dropped to a 6-year low. Investors panicked. Impulsive investors rush in and out of the equities, gold and bond markets  as fears of a double-dip recession, bleak jobs reports and the ebbs and flows of destabilizing debt in the US and Europe rise and fall. Thank god machines are not interested in fundamentals (I say that facetiously of course, in regard for those sentiment-based news and social media strategies).

There are so many market mechanics that can contribute to volatility.  On any given day as declines build, stop-loss orders trigger further accelerating the drop. And as Matt Samelson so eloquently outlines “short-covering begins …” which itself is another trigger point that reverses the price direction.  Enter in the human emotional factor; the panicked institutional and retail investor,  the short selling circuit breaker which causes market rebounds every other day, as Steve Wunsch describes and you have the recipe for a whipsaw market, inviting pundits to scream for a scapegoat and catching the icy glare of suspicious regulators.

Yet what is HFT’s role in all this?  ”In any 5 minute period, I am buying as much as I will sell … By the end of the day, I will be flat“. a basic model of nearly any HFT strategy as mentioned in a recent CNBC commentary. The empirical evidence to determine if such models are the cause of market volatility was recently published by Alex Frino, chief executive of the research group Capital Markets Cooperative Research Centre. His research indicated that HFT may actually decrease price volatility. This is not the first research paper published that indicates such findings. Yet despite the factual affirmation, there remain philosophical differences based on prejudged opinions creating an impasse between the HFT firms and those pitted against them for the reasons I mention above.  It’s simply a matter of ideology. Factual evidence aside, there is not much of a chance to sway an opinion.  A better path is to concede and cooperate.

While August’s volatility is not analogous to the May 6th flash crash it nonetheless puts the regulatory authorities under pressure to gain better control and understanding of our markets to ensure market integrity for all participants. To that end, the SEC and the CFTC have plans to expand their headcount in the coming year by nearly 1000 employees. No doubt they will fill positions to accelerate the implementation of Dodd Frank, but also are likely to focus on the development and deployment of the Consolidated Audit Trail by which they hope to be able to conduct the needed research to determine the cause of market anomalies.  As the cold-hard facts of current research have already shown it will affirm that HFT has brought some benefits to the market. Yet for the detractors to concede HFT’s benefits, transparency and cooperation with regulators will be needed by the HFT firms.  For the benefit of all participants there has to be an incentive to work collectively, even against short-term self-interest.

It was the August winter of our market’s discontent.  Yet the storm is far from over nor is the voyage done. Those intrepid arctic adventurers of long ago that sailed through the unchartered vastness of ice were out to prove more than the existence of sea route across North America but that it was a commercially feasible one.  It took nearly 200 years and global warming to reduce the pack ice enough to make the waterways navigable. Let’s hope it doesn’t take that long to navigate through the volatility.

Once again thanks for reading.
Louis Lovas
For an occasional opinion or commentary on technology in Capital Markets you can follow me on twitter, here.

Over the past two weeks I have traveled to Chicago and San Francisco to attend and speak at Stacey Mankoff’s recent conferences. The events were focused on new markets, new regulations, strategies for build vs. buy and high frequency trading for Chicago and west coast trading firms.  As a panelist at events such as these I try to set a goal to inform, educate and instruct in an effort to share my understanding of the industry so the audience can walk away with a positive sense that they’ve learned a thing or two.  By the evening’s end and the trip overall I got a sizable dividend in return discovering numerous firm’s own investment in HF trading and perspectives on regulation.

The media frenzy is heating up once again on regulation and its impact on high frequency trading. Discussions of Dodd Frank, talk of new regulations for a transaction tax, surcharges on order cancellations, limit order minimum durations and of course the Large Trader rule that came into force just recently have caused the number of articles to reach hysteria levels.  I would describe it all under the “Dead Cat Rule” – can’t swing a dead cat without reading or hearing something about the topic of regulation and HFT. Of course all of this was discussed at both of Stacey’s Chicago and San Francisco events.

It’s no surprise that regulators have drawn a bead on HFT firms; this is deeply rooted in the May 6th flash crash.  That event drew back the curtain to reveal the fragile nature of the liquidity supply feeding our markets. HF firms in their quest for alpha whether takers or market makers never envisioned themselves as the lynchpin of market integrity, where traders and quants are responsible not only for the profitability of their firm but also to a degree are accountable for the orderly and fair operation of markets. Yet in the aggregate their influence and affect is obvious and thus all the attention of regulators (and the media chasing behind).

For the Chicago trader, the focus is talent, technology and tuning strategies. Many still rely on time-tested alpha strategies and simply look to fine tune them as markets restructure. It’s the underlying technology infrastructure that becomes a moving target. Most know that the evolution in technology goes hand-in-hand with innovations in trading. As for the talent, here’s a comment from a fellow panelist: “It’s easier to teach finance to a programmer than programming to a finance guy“. The context of course is for algo development. From my perspective, it’s also very logical to make algo development tools more amenable to finance guys as well.

In San Francisco, it looks to be quite different. The issue is not concerns of regulation’s impact, but “how do I get into this HFT game?”  If the firm’s I spoke to are representative of the west coast at large then the top priority is ways and means of launching into high frequency trading. They’re investigating where to begin that initiative; what technologies are needed? what are the build vs. buy decisions? which asset classes? etc.  The “impact” concerns are centered around how HFT will disrupt their business models, trading styles and the associated costs. Regulation’s long arm is far down the priority list.

Yet the regulators heavy hand could produce a very different outcome.  Over the past year there have been numerous controls enacted to reduce the chance of another liquidity starved crash and arguably improve market quality (reduce volatility, improve liquidity) through the elimination of stub quotes and the addition of circuit breaker trading halts and limit up/limit down price collars.   But in chasing that elusive goal of market integrity recent talks of a transaction tax, order cancellation fees and/or minimum resting periods for limit orders could change the game completely.   Existing firms hit with new regulations will likely close down and new entrants will think twice when they consider the costs and the lowered margins.  

The perception is HFT firms have a technological advantage, yet technological change is multi-dimensional it relates to all participants; buy-side, sell-side, HFT, exchanges and brokers. In an effort to swing the balance back in their favor the sell side is combating (HFT) technology with technology.  I spoke with a sell-side firm in San Francisco that has revamped their block trading algos to disguise them from the HFT liquidity detection schemes, a move similar to Deutsche Bank’s new Stealth Algo.  Market integrity ultimately will be based on creativity and its innovative application to technology in trading.

Harry Truman was known for his straight-shooting style. Yet in this simple comment, “The only thing new in the world is the history you don’t know” what I think he was really saying is the lessons of history have much to teach, so much of what has the appearance of newness has been done before by past generations. Granted we live in an era of fast-paced technological change but driving that change is still the human mind.

Once again thanks for reading.
Louis Lovas

For an occasional opinion or commentary on technology in Capital Markets you can follow me on  twitter, here.