No leaks, just algo trading

Posted by Izabella Kaminska on Jun 16 15:07. 9 comments | Share

Everybody loves it when a high frequency trading strategy is exposed. So, here’s a new one courtesy of the guys at Nanex — algo analysts extraordinaire.It’s connected to stories like this.

Turns out, More…

Everybody loves it when a high frequency trading strategy is exposed. So, here’s a new one courtesy of the guys at Nanex — algo analysts extraordinaire.

It’s connected to stories like this.

Turns out, people are increasingly noticing huge bursts of trading activity just ahead of major data releases. Literally moments before the official release time.

On the surface of it, the activity implies that someone is possibly leaking or pre-releasing the data selectively.

Nanex’s Eric Scott Hunsader believes that’s a red herring.

In his opinion the activity is much more likely the obvious tell of a high-frequency trading strategy in action.

Take the release of the University of Michigan Consumer Sentiment Index. Nanex noticed that a burst of activity in many major equities, futures and ETFs has been taking place at exactly 9:54:58 am on every second, third and fourth Friday of every month.

The below is an example of the trading patterns that are being seen, in this case the e-mini S&P 500 future. The chart is colour coded for market depth (the colder the colour the less depth):

The timing is notable because the data is supposedly only released to the public at 9.55 am.

So why, asks Scott Hunsader, is the market reacting — sometimes violently — a full two seconds before the release?

His theory is that the algos are being programmed to take advantage of the so-called ‘quiet’ before the data- release storm.

The period is ideal because it provides the algos with a unique opportunity to move a market subtly yet very much predictably — at the same time as sparking a series of trading chain reactions, which can be easily navigated and front-run pre-anticipated in a variety of related options, ETFs and equities. Safe in the knowledge, we might add, that a sizeable order flow is coming right around the corner, but which is now just sitting on the sidelines.

As Scott Hunsader explains, normally the bid/ask spread in most of these active stocks and ETFs is as tight as a penny wide. However, when these strategies are in use the spreads tend to increase very rapidly indeed, often becoming locked (where the bid price equals the ask price) or crossed (where the bid price exceeds the ask price).

Note the following example from one of these trading events.

In the chart the spread is coloured in red if the bid/ask is locked, yellow if it is crossed and grey if it is normal. The dots indicate real trades and are coloured according to the exchanges they were transacted on:

Scott Hunsader explains further:

As an HFT there is a distinct advantage to cause volatility. When the market is anticipating the release of a news event, the depth of orders in the eMini futures order book drops to about 1/3 it’s previous levels over a period of 5-30 seconds.

We typically see the emini depth go from 20,000 on each side (20,000 spread out over 10 buy levels, and about the same on the 10 sell levels) to between 5,000 and 10,000.

At lower depth levels, it becomes much easier for someone to move the eMini price suddenly — at the reduced level you only need to buy or sell about 1,000 contracts to run through 3 to 4 levels of the book immediately.

That causes an explosion of quotes and trades on the related ETFs, equities and options — the level of data nearly always causes saturation and delays — from cqs to direct feeds.

Which means, insufficient market depth presents great opportunities for algo traders especially when it coincides with a known high activity trading period to come.

Perhaps it also explains why initial reactions to data releases sometimes make so little fundamental sense nowadays and why they are often reversed a matter of minutes later?

Though sometimes it doesn’t even take a data-release. Any low depth scenario will do. As Scott Hunsader observes:

The instantaneous selling of emini futures and accompanying explosion of quotes that you see at 9:54:58 is becoming more common and occurs throughout the trading day. Yesterday there were 9 such events. Typically 1500 to 3000 contracts are involved in each event. Once (April 8, 2011 at 14:56:28.800) we saw about 22,100 contracts dumped on the market within 2 seconds! So much for the W&R algo selling too much!

Related links:
An algorithim running backwards in natural gas
– FT Alphaville
The annotated flash crash diagram
– FT Alphaville

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