A few days ago, Credit Suisse did something profoundly unexpected: its Trading Strategy team led by Jonathan Tse released a report titled “High Frequency Trading – Measurement, Detection and Response” in which the firm – one of the biggest flow and prop traders by equity volume in both light and dark venues – admitted what Zero Hedge has been alleging for years (and has gotten sick and tired of preaching), and which the regulators have been unable to grasp and comprehend: that high frequency trading is a predatory system which abuses market structure and topology, which virtually constantly engages in such abusive trading practices as the Nanex-branded quote stuffing, as well as layering, spoofing, order book fading, and, last but not least, momentum ignition.
This is Credit Suisse, an entity whose incremental input we are confident will be very much welcome by Congress and the regulators, not some fringe, tinfoil hat blog.
While we we cover the full report in the next few days and all its SEC-humiliating implications, it is the last aspect that we wish to focus on because while all the prior ones have been extensively covered on these pages in the past, it is the phenomenon of momentum ignition that goes straight at the dark beating heart of today’s zombie markets: momentum, momentum, and more momentum, in which nothing but stop hunts and even more momentum, define the “fair value” of any risk asset – i.e., reflexivity at its absolute worst (in addition to Fed intervention of course), where value is implied by technicals and trading patterns, and where algos buy simply because other algos are buying. Behold robotic stop hunts: HFT-facilitated “Momentum Ignition.”
From Credit Suisse:
What is Momentum Ignition?
Momentum ignition refers to a strategy that attempts to trigger a number of other participants to trade quickly and cause a rapid price move.
Why Trigger Momentum Ignition?
By trying to instigate other participants to buy or sell quickly, the instigator of momentum ignition can profit either having taken a pre-position or by laddering the book, knowing the price is likely to revert after the initial rapid price move, and trading out afterwards.
Likelihood and Rapid Price Moves
Momentum ignition does not occur in the blink of an eye, but its perpetrators benefit from an ultra-fast reaction time. Generally, the instigator takes a pre-position; instigates other market participants to trade aggressively in response, causing a price move; then trades out. We identify momentum ignition with a combination of factors, targeting volume spikes and outsized price moves – see Exhibit 18 for a example of this pattern in Daimler on 13th July, 2012:
To pinpoint momentum ignition, we search for:
- Stable prices and a spike in volume (Box 1 in Exhibit 18)
- A large price move compared to the intraday volatility (Box 2)
- Reversion (Box 3)
Though we cannot conclusively determine the intention behind every trade, this is the kind of pattern we would expect to emerge from momentum ignition. We use this as a proxy to estimate the likelihood and frequency of these events (further details are provided in Appendix 4).
Likelihood and Rapid Price Moves
As shown in Figure 19, we estimate that momentum ignition occured on average 1.6 times per stock per day for STOXX 600 names in Q3 2012, with almost every stock in the STOXX600 exhibiting this pattern on average once a day or more.
In addition, we note that the average price move is 38bps (but over 5% are more than 75bps, with some significantly higher – see Exhibit 20), and the time it takes for that move to occur is approximately 1.5 minutes (see Exhibit 21).
While 38bps may not sound like a big move, it is a bit more significant when compared to the average duration of these events (1.5 minutes) and the average spread on the STOXX600 (approximately 8bps).
Though not all momentum ignition events result in massive price moves, those that do can cause significant impact. Percentage of volume orders that would normally execute over hours may complete in minutes on the back of “false” volume ( one of the causes of the 2010 flash crash was a straightforward percentage of volume order). AES offers a variety of protections to help mitigate this kind of dislocation, including customised circuit breakers, active limits (that kick in when the stock decouples from a specified index) and fair value limits.
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Much more on HFT being finally exposed by “credible” sources tomorrow.