Wednesday, 9 March 2016

a few trading anomalies suggest strange forces at work

It is almost impossible to think of that movie 'The Sting' without mentally hearing Scott Joplin's rag-time music that was its theme tune.

The plot was about the delayed results of a horse race relayed from coast to coast relying on the delays inherent in the wire system to cheat the results. The scam was referred to as 'the wire' and was already obsolete when it was used in the time of the movie because the technology had been overtaken.

That was in the days when messages were delivered slowly in morse code. Since then, things have speeded up and we now get into the realm of very fast switching.

I've been dabbling with the stock markets, purely in the interests of investigation, and noticed a few odd facts.

I know my own trading system uses delayed information, even when it is set to show real time figures, but there's enough information to notice a few phenomena which somehow remind me of that movie.

First, the closing price and the next opening price of the same exchange are different. Those closing bells are rather symbolic because of the amount of out-of-hours trading. A jump of a few points on FTSE or NASDAQ may not seem a lot, but it is surprisingly common and means that someone has been making money from the side-lines.

Then, the amount of trades that don't seem to be made on the main exchanges at all.

Mere punters like me would use the main exchanges, but the serious players go off into another world known as 'dark pools' where they can exchange their shares at separately agreed rates, which could be different from those displayed in the main market.

In the USA, nowadays about half of the total trades are outside of the main exchanges. That's changed upwards since 2003, when 80% of the trades were inside the main systems.

And on top of that, there's the people operating like in that movie, who know the differences between the individual dark pools and the main market. In effect they are playing with the time delay before all the numbers resynchronise.

They are the so-called High Speed Traders.

I won't call them investors because they are simply in it for the turn on the money and may only keep particular shares for a matter of seconds.

Which brings me to the point about speed. If morse code was slow, then nowadays it is possible to transact in milliseconds, heading towards nanoseconds. All of a sudden the length of a millisecond becomes highly relevant.

I once attended a session where someone explained a nanosecond. He borrowed from Grace Hopper's presentation of the same thing. The amount of distance covered by electricity or light in a nanosecond is around 30cm (11.9 inches)

A whole second at light speed is, well, around 300,000 kilometres. Let's halve it for resistance etc. That's still the kind of speed/distance that suggests an awful lot of computer circuitry can be used in just a tiny delay.

So this is how it works.

Spot a trade, run in front of it to market, buy some, watch the price rise from the following orders, then sell and scrape off the profit, returning the price to its true value.

HST traders nowadays front run trades in those milliseconds of delay. It's not illegal, although some might find it questionable, save for the exotics that mean most folk won't really know about it.

No wonder the high speeders all want to put their computers close to the market exchanges.

Short distance = more milliseconds of advantage. Kind of like that movie, only legal.

#MFOR, not #Money For Old Rope in this case., more #Money from optic reduction.

Expensive to implement, but then money for doing very little.

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