Abstract
ANDREW BROOKS: This has been a difficult decade for equity investors. It was a decade characterized by two generational bear markets followed by this incredible afternoon earlier this year, the Flash Crash on May 6.
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Notes
- 1.
For summary, see, Findings Regarding The Market Events of May 6, 2010, September 30, 2010. See, http://www.sec.gov/news/studies/2010/marketevents-report.pdf
Also, a non-governmental account on May 6 is offered in this provocative opinion piece, one of the many commentaries on the events of May 6, Flash-Crash Story Looks More Like a Fairy Tale, Michael Bunchanan, Bloomberg, http://www.bloomberg.com/news/2012-05-07/flash-crash-story-looks-more-like-a-fairy-tale.html.
- 2.
Findings Regarding The Market Events of May 6, 2010. Report of the Staffs of the CFTC and SEC to the Joint Advisory Committee on Emerging Regulatory Issue, http://www.sec.gov/news/studies/2010/marketevents-report.pdf
- 3.
See, SEC-CFTC proposed trade at rule could increase expenses and reduce revenues for retail brokers, Grant Thornton, May 24, 2011 http://www.grantthornton.com/staticfiles/GTCom/Financial%20services/Financial%20Bulletin/Fin%20Bulletin_trade-at%20rule_Grant%20Thornton%20LLP.htm
Additionally, aside from the proposed rule above, there are several related regulatory rule changes, significantly the SEC FORM 13H large trader reporting which requires “self-identification,” by December 1, 2011 and brokers to begin reporting any Unidentified Large Traders by April 4, 2012.
- 4.
Behind the Drop in Trading Costs, Traders Magazine, January 2011, Peter Chapman http://www.tradersmagazine.com/issues/24_318/trading-costs-lyons-cronin-106923-1.html
- 5.
Bob Gasser, CEO of Investment Technology Group, told attendees at the Security Traders Association’s 77th Annual Conference in Washington, D.C., in September 2010 that he would support fees for some message traffic. Gasser made this and other suggestions as part of his presentation describing ways he felt the industry could strive to avoid another similar May 6 Flash Crash. For one thing, Gasser suggested messaging fees could help limit traffic that doesn’t add to overall market liquidity. “One thing we have been seeing is bursts of message traffic and anyone managing their own market data will tell you that the spikes are… scary during a period when there really isn’t a lot of trading data,” he said, referring to market data reviewed by ITG. He added that the fees could be a way to help pay for the consolidated audit trail proposed by the Securities and Exchange Commission. “Folks that participate in the behavior need to share in the burden it creates for all of us.”
Gasser also mentioned rules the regulators had proposed to additionally govern dark pools, naked sponsored- access and flash orders. He also mentioned the single-stock circuit breakers, at the time in a pilot period, and agreed the SEC is right to require the exchanges to adopt the same thresholds.
Source: Wall Street Letter, Jeanene Timberlake, September 09, 2010:
- 6.
Gasser explained in a follow-up that the first “Flash Crash” occurred on May 28 1962.
- 7.
Review of the Market Events of May 6, 2010, IIROC, http://sdocs.iiroc.ca/English/Documents/2010/C6CB526F-9325-4DED-9F4F-98CDCB935FF3_en.pdf.
- 8.
As the Canadian Securities Administrators noted in October 2008, in their rulemaking on trade-through protection: “This approach is different from the one adopted in Regulation NMS in the United States, which provides protection only to the best bid and offer on each marketplace (top-of-book).”
- 9.
The rules finalized by lawmakers in Canada in 2001 to provide the framework for multiple marketplaces, took effect in 2005.
- 10.
“It is also important to note the trade through obligation in Canada is a “full depth of book” obligation. As such, orders in Canada could not bypass any visible, better-priced orders on other marketplaces and the price decreases were slowed until all liquidity was exhausted. This should be contrasted with the situation in the US where order migration from some of the markets that employed volatility controls or experienced market data issues was significant and the securities traded to increasingly lower levels without the obligation to trade with all better-priced orders in transparent markets.”
Source: Page 17, Review of the Market Events of May 6, 2010, IIROC, http://sdocs.iiroc.ca/English/Documents/2010/C6CB526F-9325-4DED-9F4F-98CDCB935FF3_en.pdf
- 11.
For update as of May 2012, see Exchange Fatigue, Traders Magazine, May 2012, Peter Chapman http://www.tradersmagazine.com/issues/25_337/nasdaq-options-exchange-109992-1.html
- 12.
Wunch, the self-proclaimed and well-respected libertarian thinker, and an advocate of limited government, is the principal inventor of the electronic Arizona Stock Exchange, now defunct, and of the ISE Stock Exchange.
- 13.
For a summary of SEC regulatory action in this matter, see, Two Years After Flash Crash, SEC Still Pursuing New Safeguards, Institutional Investor, May 11, 2012, Michael Peltz, http://www.institutionalinvestor.com/Article/3023836/Two-Years-After-Flash-Crash-SEC-Still-Pursuing-New-Safeguards.html
- 14.
Findings Regarding The Market Events of May 6, 2010. Report of the states of the CFTC and SEC to the joint advisory committee on emerging regulatory issue, http://www.sec.gov/news/studies/2010/marketevents-report.pdf
- 15.
Securities Industry and Financial Markets Association.
- 16.
Consolidated Audit Trail Rule Imminent, Traders Magazine, John D’Antona Jr. http://www.tradersmagazine.com/news/sec-consolidated-audit-trail-q1-109796-1.html
- 17.
In the context of Mecane’s remarks, recommended reading is the testimony of Larry Leibowitz, chief operating officer of NYSE Euronext before the House Financial Services Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises, May 11, 2010. http://www.house.gov/apps/list/hearing/financialsvcs_dem/leibowitz_5.11.10.pdf
- 18.
For a summary of SEC regulatory action in this matter, see, Two Years After Flash Crash, SEC Still Pursuing New Safeguards, Institutional Investor, May 11, 2012, Michael Peltz, http://www.institutionalinvestor.com/Article/3023836/Two-Years-After-Flash-Crash-SEC-Still-Pursuing-New-Safeguards.html
- 19.
On a national level in the US, the “monopoly” exchanges and markets he refers to were the New York Stock Exchange, American Stock Exchange and later NASDAQ.
- 20.
See History of ISE, http://www.ise.com/WebForm/viewPage.aspx?categoryId=504
- 21.
Market makers do have this obligation at the ISE. In fact, they are fined and sanctioned if they pull their quote in certain instances. Katz is saying that market makers would rather pay these fines in periods of market stress and volatility rather than lose potentially more in capital and money by continually posting their two-sides quotes.
- 22.
See, Guidance Respecting the Implementation of Single-Stock Circuit Breakers, IIROC, Feb. 2, 2012, http://sdocs.iiroc.ca/English/Documents/2012/7cf90cce-57ae-4760-822a-46b1525e2051_en.pdf
- 23.
Since there was no industry-wide consolidated audit trail on May 6 that necessitated much more expansive data storage, some market data from May 6 was not retained. It was “expunged.” Generally, however, financial services firms keep market information as required by regulators.
- 24.
High frequency trading strategies often involve “pinging” – sending out hundreds of IOC (immediate or cancel) orders or bid/ask quotes which are good for only milliseconds. They are trying to sniff out a “real” order, i.e. a big slow-moving order by a non-HFT trader. These are the aberrational or flickering quotes Gasser is referring to. Some analysts say they create an illusion of deep liquidity when in fact it’s mainly “noise.”
- 25.
See, Smart Order Routing Systems Getting Smarter, John Dodge, Securities Technology Monitor, April 5, 2010, http://www.securitiestechnologymonitor.com/issues/22_7/-25026-1.html
- 26.
Many algorithms and smart routers are “commoditized,” Gasser explains. Thus, each VWAP algo from several brokers operates much the same. Gassers point is that these “plain vanilla” algos and smart routers tended to operate in lockstep during the Flash Crash.
- 27.
Stub quotes are bids for stocks near zero. For example, 27.01 bid for a stock trading at $25.00. Erroneous trades are errors due to mistakes on the part of one of the counterparties, incorrect or stale market data.
- 28.
This is referring to the rebate strategies operated by market centers such as ECNs and ATS.
- 29.
Some traders regard the order flow that is handled directly by a stock exchange as “exhaust,” it is regarded as inferior to the order flow traded off the exchange.
- 30.
New York Stock Exchange and NASDAQ.
- 31.
Review of the Market Events of May 6, 2010, IIROC, http://sdocs.iiroc.ca/English/Documents/2010/C6CB526F-9325-4DED-9F4F-98CDCB935FF3_en.pdf
- 32.
Mecane is referring to price limits on some stocks that would temporarily stop trading if they traded outside pre-defined limits. For a summary of SEC regulatory action in this matter, see, Two Years After Flash Crash, SEC Still Pursuing New Safeguards, Michael Peltz, Institutional Investor http://www.institutionalinvestor.com/Article/3023836/Two-Years-After-Flash-Crash-SEC-Still-Pursuing-New-Safeguards.html
- 33.
The Chicago Board Options Exchange Market Volatility Index.
- 34.
For summary, see, Findings Regarding The Market Events of May 6, 2010, September 30, 2010. See, http://www.sec.gov/news/studies/2010/marketevents-report.pdf.
Also, a non-governmental account on May 6 is offered in this provocative opinion piece, one of the many commentaries on the events of May 6, Flash-Crash Story Looks More Like a Fairy Tale, Michael Bunchanan, Bloomberg News, http://www.bloomberg.com/news/2012-05-07/flash-crash-story-looks-more-like-a-fairy-tale.html
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Brooks, A. et al. (2013). May 6: Lessons Learned and Questions Raised. In: Schwartz, R., Byrne, J., Schnee, G. (eds) The Quality of Our Financial Markets. Zicklin School of Business Financial Markets Series. Springer, New York, NY. https://doi.org/10.1007/978-1-4614-5592-9_3
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