[Infowarrior] - Robots Rattle Data Guru

[Richard Forno]

http://online.barrons.com/article/SB50001424052970203560404576228920925930788.html

SATURDAY, APRIL 2, 2011

Robots Rattle Data Guru

By JIM MCTAGUE | MORE ARTICLES BY AUTHOR

A savvy market watcher has detected some suspicious -- and very, very fast -- automated-trading activity in March. Flash Crash 2?

New robotic-trading strategies are attempting to hack futures and equities markets -- again. The suspicious activity appears unconnected to the October cyberattack on Nasdaq OMX Group (ticker: NDAQ) now being investigated by the National Security Agency. But there seems to be a new team of trading 'bots abroad -- and yes, they're distorting prices.

The suspect algorithms first appeared March 2, Eric Hunsader, founder of Nanex, a Winnetka, Ill., data firm, tells Barron's. When rapid-fire automated-trading systems torched the indexes in the infamous May 6, 2010, "flash crash," Hunsader was the first to notice that the Consolidated Quote System (CQS) was running 35 seconds late.

Hunsader's Nanex delivers trade data from multiple markets over the Internet to retail and institutional clients. When the New York Stock Exchange discovered gaps its trading  data for May 7, 2010, it purchased Nanex data from a third-party vendor to fill in the blanks. The data are sold to institutions for back-testing.

Automated systems are programmed by mathematicians whose ultra-short-term strategies have radically altered markets. And while there have been flash-crash fixes, they haven't stopped the new invaders, which are orders of magnitude faster.

Hunsader theorizes that one new algorithm appears to be trading E-mini S&P 500 Futures (they're a fraction the size of standard S&P futures contracts) at the Chicago Mercantile Exchange. The algo alters the prices of related instruments, like index-based the SPDR S&P 500 (SPY) exchange-traded fund and underlying Standard & Poor's 500  stocks and options -- creating arbitrage opportunities; when it's active, the bid-ask spread on SPY as traded on Nasdaq's Philadelphia exchange sometimes widens from a penny to a dollar. The spreads on the SPY stay within a penny on other exchanges.

And, says Hunsader, the algorithm instantly buys or sells enough E-mini contracts to trade through the top three levels of the electronically displayed order book in about 50 milliseconds. He detected the trading pattern on 18 days in March. The CME had no comment.

Another algorithm, says Hunsader, changes order sizes at the top of the order book in about 20 to 40 stocks on Nasdaq for a few milliseconds several times a day. Each stock is traded anywhere from 2,000 to 4,000 times a second, double to quadruple the norm. The activity floods the quote system with trade data, but so far seems to cause no harm. On March 16, the CQS saw peak-volume traffic hit warp speed: a record 390,000 messages per second for all stock symbols between 11:01 a.m. and 11:02 a.m. (A year ago, such volume would have swamped the CQS, as peak capacity was 200,000 messages a second.) At 11:01:48 a.m. -- the peak of the weird trading -- 10.5% of the quotes on CQS were locked or crossed, meaning that the bid exceeded the offer. The next second, it was 13%. Usually, about 3% of trades are crossed.

Hunsader wonders why the exchanges are not saying that they are worried.

This is all too similar to what happened during the 2010 flash crash, causing the delay that went unnoticed by regulators and market experts -- despite all their monitoring equipment. Meanwhile, CQS has been upgraded to handle 750,000 messages a second; by July, total capacity will be one million messages per second... What helps legit trading will also help fast hackers.