Wednesday, August 18, 2010

One Man's Meat is Another Man's Poison

As algorithms in US markets chug away - cheerfully gaming each other and quote stuffing - two men in Norway have been arrested for doing something very similar. According to Zerohedge, day traders Svend Egil Larsen and Peder Veiby face up to six years in jail, for reverse engineering a stock trading algorithm used by broker Timber Hill, which is Interactive Brokers' key market maker. They found a weakness in it and took advantage of it to (allegedly) artificially inflate the share price of three companies listed on the Oslo Stock Exchange.
That Norwegian regulators have taken a hard line on this sort of activity is interesting, especially as here in the US the regulators have not even begun to drill down into high frequency trading practices. While HFT and quote-stuffing algorithms are widely believed to have caused the market meltdown of May 6th, little has been done to try and rein in dodgy practices.
A global body of regulator, the International Organization of Securities Commissions (IOSCO), is also concerned. It proposes tougher guidelines to monitor high-speed traders - particularly those with direct market access to exchanges. Calling it "direct electronic access", IOSCO says that securities markets should be monitored for risky practices both before and after their trades are made.  This is not a novel idea, the SEC is also proposing that brokers deploy pre-trade risk controls for their DMA or naked access clients. Brokers, and their clients, are not impressed with this idea because it could add a latency "hop" of maybe milliseconds to their trades.
But given that almost 40$ of trades in US stock markets is via naked access, it is time someone took action. Another flash crash is lurking, and fat fingers or outright fraudulent trades can set it off far too easily. The SEC has to get off the pot.

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