DAYTONA BEACH, FLORIDA (Photo credit: Wikipedia)
The Facebook IPO gave many investors the same queasy feeling about U.S. markets that used to inspire June Cleaver’s signature line, “Ward, I’m worried about the Beaver.”
The Beaver in this case is not a charmingly erratic teen, it’s the collection of ever faster and more complex and interconnected systems and networks that collectively form our “new and improved” electronic securities markets. Alas, like the Beaver, they seem to be capable of impressively flakey behavior.
Facebook’s IPO stumbled, but it did actually work as an IPO -- it got cash to the firm and stock to the investors. That's far better than BATS' IPO in March, which was called off and did neither. Business Insider dubbed it “The Worst IPO Nightmare Of All Time.” It was particularly embarrassing for BATS because it's a stock exchange and the company used its own platform for the aborted IPO. BATS did extensive testing, but we saw a mini meltdown just the same. U.S. market participants don’t seem to have access to reliable simulations for these sorts of tests.
One academic paper counted almost 20,000 market anomalies over a few years, though they did use a low bar.
Why does this keep happening?
Not to mince words, we are lost in the jungle when it comes to our ability to understand ever-faster markets well enough to keep them safe, stable and secure.
The Flash Crash was the poster child for the lack of information about markets, and tools to figure out what they were doing. It took five months between the event and report. The big fish know the story (from MarketWatch):
CFTC Chairman Gary Gensler said that one reason it took so long to conduct the review is because it was an “enormous” effort to collect and analyze all the trading data on May 6. He added that the agency sought full order book data from market participants to examine the events on May 6, noting that the agency does not have the resources to collect or examine this kind of information on a daily basis.
“We need people with capacity in data management, quantitative analysis and servers and system capability to receive something on the order of 20 terabytes of data in a month,” SEC Chairman Mary Schapiro said.
Firms can do isolated testing, but when many thousands of systems interact over real networks with real delays, weird stuff can happen. This is an extension of an idea voiced by Jeff Goldblum’s character in Jurassic Park: “be careful how much complexity you ask for.”
Weirdest Chart of All Time
The picture below is a leading candidate for the weirdest market chart of all time. It shows shares of Accenture trading at one cent and more than $30 in the same second during the Flash Crash. You can get your own souvenir version on page 35 of the preliminary SEC/CFT report, plus many other interesting items throughout.
That’s pretty strange, but it’s pretty strange when you look at all of them as well.
Weirdest Group Portrait of Stocks
The picture below shows the S&P500 stocks during the Flash Crash, it’s a frame grabbed from an animated version by Panopticon. The full movie version, along with other visualizations is here. Many stocks saw little or no drop in price, with jumps in volume. In the picture, price change is the vertical axis, and relative volume the horizontal. We have a few sinking boulders, but many more drifters.
Pop Quiz!
Now that we’ve looked at the pictures, please fill in the blanks in the sentence below:
“______________ feared … increasing speeds significantly surpassed the abilities of the _______ technology of the day, and it would undoubtedly increase the number of gruesome wrecks that were occurring.”
Many readers might say “Investors feared ... increasing speeds” that might surpass the “market technology of the day.” The actual quote? Insert "Nascar" in the first blank and "tire" in the second.
I once visited the Nascar Hall of Fame in Daytona Beach, and was surprised to learn how restrictive the limits placed on cars had become to maintain safety. They basically said, “this fast is fast enough for the level of risk we accept.” They have the ability to slow down for safety. This seems like a good idea, but it's not one found in our financial markets currently (though sudden circuit breaker stops are allowed.)
Nascar puts out a Yellow Flag when it gets too fast for safety. Can markets do the same thing? There are lots of reasons to think they can. The WSJ’s Jason Zweig offered a high level view in “Could Computers Protect the Market from Computers”.
A deep dive into how a market yellow flag might work is offered by the inventors of VPIN – the head of HFT research at a major hedge fund and two esteemed Cornell professors. Their secret sauce is, partially, to measure in “volume intervals,” instead of clock intervals (eg, seconds), which makes measurements on low and volatile volume securities make more sense. Readers who don’t mind a little math can get started on VPIN here.
Real networks and real computers make real errors
