It all happened in a matter of seconds, but the lasting ramifications is evidenced by the ruined confidence in the market place in terms of real human investors. The culprit was a high frequency trading tactic called, “Quote Stuffing,” which occurs when a trader places a bid of zero while placing an asking price of a 1,000,000. The idea behind this tactic was to slow down the extremely fast leveraged computers that were buying and selling faster than the human traders could place the order in the markets. On that horrible day the various traders overwhelmed the system with quote stuffing orders, until the stock prices fell too zero. The market reaction was full of shocked reporters, investors, and company owners. The exchanges and the various regulators went to work spinning up new rules that would surely prevent such a calamity from happening again. I think they missed the point entirely.
The fact of the matter is that high frequency traders (HFT) are pre-programmed machines that rely on both historical data and they monitor specific variables (for example: economic indicators) when they buy and sell. Think of them like watching the news on TV for an extended period of time. After a while the reporters are saying the same thing over and over again, its called a “News Cycle” in the media industry. The only thing that breaks the monotony and repetition is a “Breaking News” story, which suddenly introduces new reporters and graphics. The problem with pre-programmed high frequency traders is that its difficult to stop them from going through their usual routine. The catastrophe in Japan and the subsequent impact on the various industries and economies need to be programmed into the computers. This is too much centralized power to be referred to as capitalism or free markets. The sheer volume of leveraged computers can manipulate the markets, without any regard for fundamentals or real time events.
Lets take a close look at a few examples from last weeks news such as the two Standard & Poors downgrades, and the Apple Computer results. 1. Standard & Poors downgraded Fannie Mae and Freddie Mac on Friday April 22nd, 2011 which was a holiday.
2. Standard & Poors downgraded The US Treasury with a “Negative Outlook” April 18th, 2011 3. Apple computer announced earnings April 20th, 2011 saying they did not have enough components to meet market demand for the iPad2.
The Quants and the media need to stop downplaying or ignoring these specific metrics. The pricing of the US Dollar, AAPL Apple Computer, Fannie Mae, & Freddie Mac must be set by the free markets. The real demand and the real supply of the aforementioned items must be the driving forces that determine Fair Market Value (FMV).
AAPL Apple computer, which seems to be ignoring real time events around the world, expounded upon their extraordinary performance in the past, while they sheepishly dodged questions about the impact of the Japanese crises on their future sales and production abilities. The world of reporters, analysts, and portfolio managers suddenly lost all their skepticism regarding the impact of Japan. They all started to act as if they were brain washed by the conference call, suddenly the stock took off as if the news cycle was suddenly synchronized with the leveraged program traders. They would literally state that there was not enough supply to create new iPad 2 tablets, and the stock took off anyway! It’s an insult to all rational investors to watch them manipulate the media and the markets with their hype. Please consider that if we had no leveraged computer programs, then the Apple’s investor relations department would have to produce a story line that would have to be logical and believable. They would have to answer the questions of real human investors in fear of being shorted out of business. Instead they act like the market is their own personal video game. They know that computer engineers are programming the markets in computer algorithms and code thats primarily found in computer languages like Matlab, Visual Basic, Java, and the like. They literally have no background in finance or economics, yet they refer to themselves with titles that allude to mathematical accuracy and precision like “Quants.” In fact a true skeptic might have to believe that the reason why all the high tech companies have all the cash on their balance sheets is because they are the ones manipulating the markets, while Goldman Sachs takes all the blame. I would like to see an investigation into the investment arm of the technology companies.
The truly frustrating part of this discussion is the expansion of the HFT programs into the commodities arena. They are literally playing with the prices of food as you can see from the charts. We should use this “Flash Crash” anniversary as an opportunity to analyze the merit of this artificial demand system. The key is to understand that the volatility in the cost of food and agriculture will impact people all around the world. While some governments like both the US and the Saudi Arabia have ongoing farm subsidy programs that buffer the normal seasonal fluctuations in commodity prices that would apply to both droughts and floods that occur in a natural way. The question at hand is how are the governments of the world going to cope with the volatility of commodity prices that is fueled with high frequency traders and market manipulators? In this author’s humble opinion we need to dismantle the current leveraged system and reinstate the rules and regulations that reinforce textbook definitions of supply and demand.
— Khalid I. Natto Chairman & CEO The KIN Consortium Email: [email protected]