Monday, May 30, 2011

High Frequency Trading and Flash Crash - Part 9: Concluding Remarks

Since this series began last October, we have established that:
  • HFT is the latest mode, i.e., the form of movement, of speculative capital in markets. Like the previous forms such as derivatives and day trading, this form first appears in the most developed markets and then, having grazed the profit opportunities there, simultaneously creates, and migrates into, new, “emerging” markets. That is signature form of the expansion of speculative capital which I described in Vol. 1:
    After arbitrage opportunities in the home market have been grazed, speculative capital sets out to find virgin markets outside the original national boundaries. This excursion begins with more developed markets. That is partly because they can more easily accommodate the large size of speculative capital. Also, the primary tools of speculative capital–derivatives–are more likely to be found in these markets. Gradually, even in these markets, the profit opportunities are arbitraged away. So speculative capital sets out to seek even more virgin territories outside the developed markets and economies. When these markets are found, they become the “emerging markets.”
    From the Financial Times of April 13:
    Low market volumes and stiff competition have led to a sharp fall in “high frequency” trading as industry experts warn that the past two years of rapid growth may be coming to a halt. Instead, high-frequency traders are flocking to emerging markets such as Russia, Brazil and Mexico where exchanges are beginning to revamp their systems to attract such players.
  • Because speculative capital dominates the markets in terms of tempo and trading volume, its modus operandi is the modus vivendi of markets. That means how markets functionally are, i.e., the way securities are traded in them. This state – how markets functionally are or the way securities are traded in them – is the result of a dialectical process and irreversible. There is no going back to the “quiet days” or “rational days” of yesteryears. The cogwheel that in practice prevents this process from going back is “efficiency”.
  • HFT eliminates the specialist and market makers system from the U.S. equities market, as it must. Speculative capital is antithetical to regulation, having been born out of a legal/regulatory vacuum in the aftermath of the Bretton Woods regime. The result?:
    With the demise of old-fashioned floor broker and traditional market makers, new so-called high-frequency equity players, which include proprietary trading desks at investment banks, have become the main providers of liquidity for the overall US equity market.
Only that the “main providers of liquidity” have no obligation whatsoever to do so. There is, in other words, no one “in charge”.

  • HFT mode of speculative capital is unstable. It constantly simulates the crash conditions and occasionally, as all simulations do, finds it. Hence, the progressively more frequent flash crashes, as the speed and the domain of the operation of speculative capital increase.
That is the situation we are currently in.

It is impossible to understand this situation without the Theory of Speculative Capital and the force that is speculative capital. In his doctrine of essence, Hegel reaches the concept of “force and manifestation of force”, as described by Stace in his Philosophy of Hegel:
Force not only does, but must, manifest itself. For it is nothing but its manifestation, and without its manifestation, it is nothing, merely non-existent. Force is not one thing and its manifestation another. They are the same thing. The force is unthinkable without its manifestation. And for this reason, too, it is absurd to say, as it is often said, that we can only know the manifestation of force but that what force is in itself must remain unknowable. It is only unknowable because there is nothing to know.
And naturally, see.

That is why various groups which investigated the flash crash of last May came out empty handed. The physicist who led the forensic study of the crash for the SEC told the New York Times that his report would “zero in on a specific sequence of events that preceded the crash and will tell a clear story about what happened in the markets on that stomach-churning day.” His report did all that but got no closer to understanding the cause of flash crash than the fellow investigation the hanging chad got to understanding Gore v. Bush presidential election controversy. “In the analysis of economic forms ... neither microscopes nor chemical reagents are of use. The force of abstraction must replace both.”

Naturally, then, in the same way that superstition grows out of ignorance of nature, Ms. O’Leary’s Cow’s school of explanation grows out of ignorance of finance: there was this broker somewhere in the Midwest and then it bought 71,000 E-Minis contracts and then kaboom – the market went bust. (To be fair, the official investigation exonerated Mrs. O’Learly’s cow in the Chicago Fire. The official flash crash investigation, by contrast, pointed the finger.)

The ignorance of theory also creates malaise. You “feel” or “sense” that there is something wrong but cannot put your finger on it, much less come up with a solution. “Theory delivers us from submissive acceptance of events just because they occur and allows us to interpret them within the body of a logically constructed system and, if need be, take action to influence them,” I wrote in Vol. 1

See this malaise in the writing of two influential U.S. senators in the New York Times of May 6, 2011:
America’s capital markets, once the envy of the world, have been transformed in the name of competition that was said to benefit investors. Instead, this has produced an almost lawless high-speed maze where prices can spiral out of control, spooking average investors and start-up entrepreneurs alike.

The flash crash should have sounded an alarm. Unfortunately, the regulators are still asleep.
Levin and Kaufman sense that something is wrong, as most people have. They refer to the “lawless high-speed maze where prices can spiral out of control”; we know exactly what they mean. They even take a potshot at the cherished American word, competition, which I said is one guise under which speculative capital self-destructs. But they do not know or understand what is happening. So they turn to regulators: regulators must have been asleep if all these terrible things happened.

But regulators are not asleep. They are in fact quite vigilant. That’s the good news. The bad news is that there is nothing they could do. They, too, must operate within the parameters set by speculative capital. All that the SEC chairwoman can do about last May’s flash crash is to express dismay:
Securities and Exchange Commission chairwoman Mary Schapiro has expressed dismay that active traders fled the stock market during the May 6 “flash crash.” … “The issue … is whether the firms that effectively act as market makers during normal times should have any obligation to support the market in reasonable ways in tough times,” Ms. Schapiro said in a speech earlier this month.
But there is no issue. It is rather the SEC chairwoman, missing the entire point of the specialist system being destroyed precisely in order for others to flee the market in tough times.

As for the destruction of “price discovery” or equities not being what they used to be?:
Mary Schaprio, SEC chairman, says: “This transformation of market structure has raised serious questions and concerns.”

She questions whether the quality of “price discovery” has deteriorated as a result of fragmentation and whether these changes to market structure could “undermine the fair and level playing field essential to investor protection, capital formation and vibrant capital markets generally”.
Well, yes, Ms. Schapiro, the quality of “price discovery” has deteriorated, and that undermines fair and level playing fields, etc., etc. What, exactly, are you going to do about it?

By way of answer, I know she does not have a word to throw at a dog.

That is where we stand now with high frequency trading and flash crash.

But where is it, this “where” we have arrived at, you might ask. Is there a way to grasp it or remember it without long concluding remarks?

I say there is. It is Kurosawa’s Ran. If you have not seen this masterpiece, I suggest you get it – buy it, rent it, download it, whatever – and watch it today. For the U.S. readers, it is a specially fitting movie in this patriotic weekend. Pay attention to the last few minutes. That is where “we” and the “markets” are in the age of HFT. The analogy is not exact – no analogy is – but I think the point will be made.

If you write back with comments, we will discuss them.