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Attention All Traders and Investors: How Are You Getting Pimped? Here’s How….

Posted by Larry Doyle on January 6, 2012 10:17 AM |

This commentary is a little lengthy, but for those involved in the markets as a trader or an investor I believe it is a great read. Please share it. LD

The other day I received a very interesting comment and question from a regular reader and active trader. This reader’s prompt compelled me to reach out to our Sense on Cents Hall of Fame legends Joe Saluzzi and Sal Arnuk at Themis Trading for a response.

If you are an active trader or an investor, I STRONGLY recommend you read this commentary. If you merely care about our markets and economy, I also STRONGLY recommend you read it.

Is this how capitalism works now? Is this the best America has to offer in terms of free market capitalism? Excuse me while I vomit.

Fred wrote the following in response to my commentary, Did Mary Schapiro Engage in a Fraud?


Forget about Standard Charter vs. FINRA, the ‘Wall Street’ related case going to the Supreme Court should involve losses suffered during the Flash Crash aka ‘unexecuted Bid- Ask orders causing undesirable trade executions’.

I’m not sure exactly how or when order execution on limit orders shifted from being triggered by actual trades to unexecuted bid-ask orders, but it has cost investors and the capital markets $BILLIONS.

Every day ‘mini flash crashes’ continue to occur, but the only time you will hear about it is when the major indexes and big institutional investors are involved. Try to purchase or sell any security with trading volume under 25,000, there is no way you can control the price you get, NONE.

Let’s say you want to buy or sell XYZ security at $10.00 so you put in either a stop order or a buy limit order. The price you get can be determined by unexecuted orders whose only purpose is to trigger trades; maybe a bid of $5.00 with an ask of $15.00. All this can happen while trade prices on the day remain fairly stable between a low of $10.10 and a high of $10.20.

In the case of either of your orders, the stop or the limit, you wouldn’t want execution because the security didn’t trade at or thru the price you were looking for $10.00.

For better or worse your order is filled by a price discovery mechanism that allows most participants no control over execution, NONE.

Would you go into Walmart and buy an appliance without knowing the price? Would you go into a car dealership and trade your car in without knowing the price? How about when your buying or selling a house, wouldn’t you want some control over the price?


Try complaining to someone. Your broker will call down to the floor and get a hard copy of the bid ask prices that triggered the trade, Your broker says “everything looks ok, there’s nothing we can do”. Try complaining to the SEC, you are told by a machine not to try to contact them again. Complain to FINRA, don’t make me laugh (cry), I wouldn’t be suprised if they initiated the changes to order execution to begin with.

LD, I’ll give you credit, you have touched on the issue, but you haven’t provided any ‘color’. A fair and efficient price discovery mechanism in our capital markets is vital.

Maybe if the SEC would provide the necessary regulatory oversite and enforcement re:price discovery, the Fed wouldn’t have to resort to the massive liquidity injections via QE.

  • LD


    GREAT QUESTION!! I am going to call on the two individuals with the best read and biggest set of balls in the industry when it comes to answering questions of this sort and highlighting them for the public.

    To whom do I refer?

    Sense on Cents Hall of Fame legends, Joe Saluzzi and Sal Arnuk of Themis Trading. A link to their site is in my blogroll.

    I will be back.

I’m back and happy to share a fascinating and insightful look behind the curtain at how our now ‘for profit’ equity exchanges work at the expense of active traders and long term investors. I thank Joe Saluzzi and Sal Arnuk of Themis Trading (you can find their blog in my blogroll and I recommend you follow them regularly!!) for the following response:


You are a victim of a market structure that has morphed over the past 15 years from a quote driven market to an order driven market. “Market makers” of today have little to no obligations. The role of a market maker and specialists used to be to commit capital and maintain orderly markets. That role disappeared as new regulations reduced the economics of market making.

The void that was created as the old market makers and specialists were driven out of the market has been replaced by HFT market makers. These are mostly private firms who make markets with the intention of adding to their bottom line.

They have no affirmative or negative obligations and they are not required to commit capital. Their average holding period is 2 seconds… when they execute, which is 5% of the time. The other 95% of the orders you see stuffing the exchanges are cancelled before you can interact with them, and worse, as by the time the slower public quote feed shows their quote, they are already cancelled, kind of like looking at a star in the night sky that has burned out millions of years ago.

A substantial amount of trading that goes on in the markets is high frequency in nature. Much of that is the “market-maker” rebate-arbitrage that goes on in the largest 150-200 liquid names/ETF’s (think BAC, WMT, XLF). Another large chunk of the HFT you see going on is statistical arbitrage.

Certainly though, and Fred sees this, there is much HFT that is predatory in nature. These bandits try to ascertain the strategies of long term investors, whether it’s Fred’s $10 limit order, or a mutual fund’s 800,000-share buy order in a mid-cap stock, being executed through some broker-algo.

These bandit traders use dark pools, odd-lots, rapid flickering and stuffing of quotes, and most importantly, enriched data feeds provided/sold to them by the stock exchanges to keep ascertaining the intentions of the owners of the market, front-run them, and sell it back to them later.

This type of trading does not cost investors a penny or two; it costs them quarters and more. We can’t tell you how many times each day we see thousands of quote changes in a stock that is barely trading, with the intention of igniting some institutional order to start trading up (they know that many institutional buyers try to be a set % of volume for instance).

These HFT bandits flicker quotes, take an offer ahead of your bid, start buying and cancelling orders, attempting the creation of momentum. They see on their data feeds every bid, revision, and cancellation THAT YOU HAVE MADE, and they have modeled when and how you will get frustrated, throw in the towel, and pay up.

Of course, the saddest part of this is that exchanges in past times were more neutral, not for-profit public entities, while today they cater to these bandits because they are their high volume customers.

The hardest hit sector of the stock market is the small to mid-cap space. This space has been “orphaned”. Small to mid sized broker dealers who used to support this space with research and capital have been driven out of the market due to the lack of economics. All that is left is the fleeting “liquidity” of HFT market makers and the amplifying effect of the predatory traders. These predators are constantly on the prowl for real orders that they can take advantage of. They hide in “dark pools” and receive indications of interests from smart order routers. It’s really is a shame that something as simple as buying or selling a stock has turned into a minefield filled with traps.

There are a few things that we would recommend: 1) Never use a market order 2) Ask your broker when you enter an order, how does it get routed? You need to see if your broker is sending your order through a smart router that is sending IOI’s (indications of interest) to other destinations. While this activity may be good for your broker, it will be harmful to your order 3) If you see stock offered at $10, direct your order to the exchange that is displaying the liquidity (some brokers offer this ability but many do not since it raises their cost).

When trading small to mid-caps, you need to minimize information leakage. The minute that a predatory HFT spots your order, you are basically at their mercy.

We know this is not the answer that you want to hear, but until we can get our regulators to fix what they created, then we just have to be extra careful with our order flow.

By the way, head of trading at TRowe Price, Andy Brooks, touches on this subject while being interviewed by the Baltimore Sun, T. Rowe Price Fears High-Frequency Computer Trading,

“The idea is not to own a piece of corporate America. It’s to flood the system with orders that are quickly reversed – or never fulfilled. Like a shill working for an auctioneer, quickly canceled offers to buy or sell create a bogus impression of demand. A study published last fall by researchers at the University of Mississippi found such “quote stuffing” to be “pervasive” among U.S. stock exchanges.

“We know that some high-frequency trading strategies have cancellation rates in the 95 percent range,” Brooks said. “So that means that 95 percent of the time that you say you want to buy 100 shares of IBM, you don’t really buy it. And that begs the question: Why have you said you want to buy? Are you trying to influence someone to do something else? And is that manipulative?”

As usual, the people who are supposed to regulate this stuff are outgunned, outmanned and besieged by lobbyists who claim high-frequency traders add liquidity and choice to the system. Kaufman, an early critic of high-frequency trading, left the Senate in 2010. But the agency is taking its time in ordering a centralized database that would let regulators see what rapid traders are really up to.

Brooks believes the SEC should consider charging fees to traders who cancel unfulfilled orders – an idea that’s even further from realization. T. Rowe Price suggests that regulators experiment with other rule changes to gauge how pointless trading could be reduced without harming liquidity.

Thank you, Joe and Sal.

Capitalism? Strikes me more as an abuse of capitalism, but we see a LOT of that behavior with a healthy dose of unintended consequences these days. Any wonder why volumes across our equity exchanges continue to drop like a rock and broker dealers are laying people off in droves?

If you do trade, I strongly recommend you follow the work of Joe and Sal over at Themis. They deserve massive credit for their work.

Navigate accordingly!!

Comments, questions, constructive criticism encouraged and appreciated. Let’s hear from some of the bandits involved in the HFT activity. What say you??

Larry Doyle

Isn’t it time to subscribe to all my work via e-mail, RSS feed, on Twitter or Facebook?

Do your friends, family, and colleagues a favor and get them to do the same. Thanks!!

I have no affiliation or business interest with any entity referenced in this commentary. The opinions expressed are my own. I am a proponent of real transparency within our markets, our economy, and our political realm so that meaningful investor confidence and investor protection can be achieved.

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