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Exchange Trading Out-Sleazes Carnival Midway

By Rick Ackerman Posted on April 25, 2012, 12:01 am EDT Last Updated April 25, 2012, 1:44 pm EDT

An amusing coincidence: I was posting to the Rick’s Picks forum a moment ago about how exchange trading has come to resemble a sleazy carnival operation, and lo, the E-Mini S&Ps have shot up six points in mere seconds. This was an after-hours move – the best time to stage these heists, since there is little legitimate buying or selling to get in the way of the perpetrators. I don’t wish to insult carny operators by comparing them to exchange dealers and market makers, by the way, since the guys and gals who work the midway at least come face to face with the rubes they are ripping off.  Not in the world of electronic trading, though.  The pros who are doing the fleecing operate under a veil of secrecy that can be lifted only by securities regulators or the FBI.

The forum thread concered trading against phantom bids and offers that seem to be there only when you don’t need them.  Café Americain’s Jesse had posted the following at his own blog: “I am not trading nearly as frequently or aggressively as in the past because a) I am getting older b) these markets are almost ridiculous. It’s like playing cards with the little girls. If I put in an order for a few thousand shares, the liquidity from a large offered set of multiple positions evaporates instantly and I close on maybe 100 shares. If I offer to buy above market but below ask I get ten ‘friends’ appearing instantly along with my bid.”

Phantom Markets

Just so. This has been our experience as well, mainly in the equity option markets. On a Level 2 trading screen, one might see 5000-up bids and offers for call options that rarely trade. So who would be offering thousands of them, and for what reason? Some might suspect high-speed (“algo”) traders, but that’s not how those guys work. Typically, high-frequency trading takes place without the display of bids and offers. How could they be reflected on a screen, given that such trades are sometimes effected at the rate of hundreds or even thousands per second? No, the phantom bids and offers that are reflected so ostentatiously have been put there by neural-network computers programmed to act only if an offsetting, highly advantageous opportunity arises.

I learned about this shell game the hard way when I worked as an option market maker on the floor of the Pacific Exchange during the 1980s. Market makers typically did not trade with each other, nor did they honor each other’s markets. Turn to one of them in a desperate attempt to buy a dozen puts or calls, and they would tell you to take a hike. Imagine my excitement when Timber Hill moved into the Microsoft pit where I traded.  The firm’s broker supposedly stood ready to honor 100-up markets in any put or call. Except that they would move those bids and offers out of range whenever some trivial market change occurred that might have given me an edge on an arbitrage. For instance, I might have been be waiting for an uptick in some obscure stock to signal an end-of-day short squeeze in computer stocks. Turning to Timber Hill’s broker, I would shout, “Buy 100 of the Jan 60 calls for 1.30.” To which he would reply, “I’m at 1.40 now.” Could their neural-networked computer have been monitoring the same obscure stock for signs of an impending market move? Possibly. More likely is that their machine was watching ten other indicators that it had learned would move before my “trigger” stock knew what hit it.

High-frequency trading operates at a level even further removed from reality. Regulators have recently begin scrutinizing this game, but merely doing so may obligate them to shut the whole business down, since there is no legitimate or even redeeming rationale for the practice. Don’t be surprised if this happens within the next twelve months. It won’t make the game any cleaner, only a smidgen less absurd.

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Is It Over for Apple?

We’ve been following Apple shares closely, since, if its spectacular bull market is over, so is the Mother of All Bear Rallies begun on Wall Street in March of 2009. Yesterday, Apple did something that should have scared bulls out of their pants. If you want to find out what, try a free trial subscription to Rick’s Picks by clicking here.

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  • Seawolf April 26, 2012, 12:54 am

    Another thing screwing up the markets are those damnable tracking ETF’s. If the majority of the investment money is going into the ETF then there is nothing left to go into the stocks that the ETF’s are supposed to be tracking. Result? Downward trend. Gold equities anyone?

    • Seawolf April 26, 2012, 3:10 am

      addendum to the above: today April 25th the top 10 holdings of the GDX ETF traded 59.5m shares.
      The ETF’s GDX,GLD and SLV traded 61.4m shares. Those shares represent money wasted on tracking ETF’s that do nothing for the price of the underlying shares. The PM market is too small to support both the equities and the ETF’s. Would someone care to prove my contention wrong?

  • bc April 25, 2012, 9:24 pm

    I blanch when I remember that on this board I snarked that anyone who still wants to gamble in equities could buy TVIX as that at least would respond to the coming volatility of a crack-up. About one week later TVIX fell in half catching many (not me) in a devastating downdraft. What can I say? There’s no place to hide from this crap, and it’s gonna get worse path forward. Caveat Emptor.

  • John Jay April 25, 2012, 7:05 pm

    Chuckster,
    I am baffled too. Pay off your house if you can manage that I guess. Other than that I would be guessing on what to do with money I want to keep safe. I will rationalize my procrastination with an old Howard Hughes quote: “Always wait until the last possible minute to make a decision, circumstances might change in your favor”.

    • Steve April 25, 2012, 10:42 pm

      Who’s house J.J. ? Debtor in possession, tenant in Fee! I guess it is better that the tithe is paid to the federal reserve system, and only the inheritible fee left annually to slave the future. I once asked who the Lord of Lands was, and the ‘magic they’ said the Division of Lands. How does something created of highly limited governmental powers own allodial title superior to a Man?

  • redwilldanaher April 25, 2012, 6:56 pm

    Talking with an intelligent guy a few weeks back at kids’ soccer practice. He’s an attorney and he is in his car catching up on “news” as he called it by reading the WSJ. Of course I let that slide right by as to not insult him by offering that the WSJ is merely another propaganda rag. He actually provides me with a litany of corruption that he’s read of lately as apposed to me being the dispenser of that type of info. The conversation goes back and forth for a while and we eventually arrive the point where I feel comfortable (socially that is) enough to suggest that it has become futile and that’s why we need to return to the loose confederation of united and independent states that was originally intended. He then tells me in these exact words “No, we have to fix it from within…” The prior 45 minutes were devoted to sharing episodes of exactly why things are too corrupt to fix them from within yet an intelligent/concerned person arrive back there yet again. My response was “Really? How has that worked out for us? Please cite on thing that hasn’t been corrupted at this point that provides you with hope to believe that things can be solved from within.” The response was a perplexed frown.

    How does this relate to Rick’s piece?

    “It’s ALL a Fraud at this point my friends.” If it wasn’t last time you looked, check again.

  • FranSix April 25, 2012, 4:09 pm

    If you look at HFT as a small portion of an options pricing model, then it falls into place. The variables of options pricing are pretty well defined:

    http://en.wikipedia.org/wiki/Dynamic_Hedging

  • Jill April 25, 2012, 4:11 am

    Yeah, the trading statistics are absurd. I may as well stop looking at them. The other day I was looking at a stock’s trades, and there were more shares on the ask (just slightly above the market price) than the entire daily volume of the stock.

    Did this move the price down? No, it didn’t. It stayed flat. Whoever it was,they just pulled the order at the end of the day, and then the stock went up several percent the next day. I guess it was a move intended to frighten people out of their shares.

    • Rick Ackerman April 25, 2012, 7:25 am

      Traders have an expression — that “opportunity moves to size.” Let a million-share offer sit on the screen for long enough and they will attack it like piranha feasting on a meaty carcass.

  • Steve April 25, 2012, 3:52 am

    Is there any ‘real’ expectation that the regulators are going to do something about anything when 10,000 criminal bankers only need to pay a bribe of a few mil to D.O.J. as witnessed over the past 4 years. When I was growing up making a tender to settle a criminal case was called bribery. Nothing changes until the people take it to the political hacks in regard to Article I, sec. 10, cls. 1; “No State Shall. . . make any Thing but gold and silver Coin a Tender in payment of Debts.” The whole thing is a fraud because the upper crust can turn a trick faster than the boy below. (now we have computer trading and those who’s system can beat the computer) The masses do not care if Goldman buys their way out of criminal behavior, and that is THE PROBLEM.

    • John Jay April 25, 2012, 2:24 pm

      Steve,
      Correct. There are now flank attacks on the entire Bill of Rights. You can be arrested, and depending on the whim of the Police State, you have no right to a trial, legal counsel, or bail. Protest at a location where the SS is on duty, and you are a terrorist felon, even if you had no way of knowing they are working there. Make a deposit for just under the 10k limit, bang you are a money launderer, they can seize your bank account, no recourse for you. If your semi-auto firearm malfunctions and fire two rounds instead of one, bang 5 years in jail, it doesn’t matter if you did not tamper with the weapon. They are spreading the word, you have no rights, we can and will bankrupt you and throw you in prison for the slightest trumped up charge. I now think that Obama was put in power because of his cloudy citizenship status and phony CT Social Security number. They knew someone would bring it up, and that Congress would ignore it, and the Court system would refuse to hear the case. They are laughing at us and saying the legal system is a farce, and we we can do anything we please. So, Duck and Cover, the Wal Mart electorate will probably re-elect Obama this November.

    • chuckster April 25, 2012, 6:11 pm

      Agree JJ, I am baffled as to what to do with my 401k anymore also. If I had stayed in market for the ‘bear squeeze’, I would have beem a millionaire. As it is I did avoid the 50% drop in 2008. I do not trust that my money (or worth) will be there when it is needed in old age. This market is not only rigged they are determined to ride out the fiat scam…until the dollar is completly worthless.

  • Rick Ackerman April 25, 2012, 3:06 am

    How very nice on a day when my commentary concerns America’s criminally rigged securities markets. Wednesday’s tout for Apple shares will look none the worse for the goosing you said has occurred. Meanwhile, Tradestation, witty and able as a homonculus, is at this moment unable to detect after-hours action in the stock.

    • gary leibowitz April 25, 2012, 3:49 pm

      Chiming in since no on else is. AAPL profits blew everyone away. Their margins, growth, etc…

      I guess that might have something to do with the 50 point move. Conspiracy still?

      &&&&&&

      Who cares about conspiracies. What matters is: Are you long or short here, Gary? I ask because, even though my recent, 555.29 correction forecast caught the 555.00 bottom within 29 cents, I’m not certain myself whether Apple, after rallying $50, is a great buy at these levels. RA

    • Steve April 25, 2012, 5:15 pm

      Profit upon slave labor, illicit gain, and unjust enrichment for the few.

    • mario cavolo April 26, 2012, 9:48 am

      I agree with your sentiment Steve, yet I am finding it quite easy to suggest that the slave labor problem is worse in the U.S. than it is in China!!…yes I’m being a bit sarcastic, but in fact, the life of a factory worker is MUCH more stable and secure than the life of a U.S. minimum wage retail worker slogging it out trying to survive…that’s a comparison I can easily stand by, unfortunately. Cheers, Mario

  • Pat April 25, 2012, 2:34 am

    AAPL was up about $40, to almost $600 again, in afterhours trading.


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