Friday funny: I scream, you scream, we all scream for global warming

davidmhoffer says: May 7, 2010 at 10:34 pm
James Sexton says: May 7, 2010 at 9:10 pm

The regulators are still trying to figure it out. P&G was just one of the erroneous trades, it was just the biggest. They cancelled almost 300 trades after the fact and there were a dozen stocks affected. Since everything is public on this stuff, I’m pretty certain they will get to root cause and it will have something to do with the computerized matching system for buy and ask prices.
The best explanation I’ve heard so far is that folks assembled an unstable computer network and didn’t realize it.
On a down 200+ day, the NYSE had a “Go Slow” put in place and unlike the past when markets were not so heavily interconnected, it did not “give time to think” but instead just shifted the “deal volume” to exchanges that were completely unprepared to handle it, so “bids” plummeted. This then “printed” low prices that triggered more selling (via automated sell programs and stop loss orders etc.) that then caused even lower prices and on and on.
Now, you might think, why didn’t the NYSE just reverse their Go Slow when this happened? Well, you see, we are all thinking in “human time” and this process unfolded in computer time. The “Go Slow” was for a very long time… 90 seconds.
Yup, in the past, the NYSE would give the floor brokers 90 seconds to take a breath, call the boss, or maybe just take that “Sell 1,000,000 P&G at market” and ask the seller “REALLY? At $40 in stead of $50?” or at least ping a major mutual fund and say “Want to pick up some P&G for $45? It’s at $50 now?” and that would be the end of it. But a few things are different now.
1) The NYSE can “go slow” and the TRADES don’t go slow with them, they go elsewhere. So, for example (not to pick on them, I just happen to know their guarantee) E-Trade has a 2 second execution guarantee. Other brokerages may be 5 seconds or even 10 seconds (for one I like to use that’s a bit more staid…).
So think about it. If you have a 2 second guarantee, and you hit the NYSE, and it’s a NO-GO, you then hit the Pacific or American or NASDAQ or “Bob’s Pretty Good Stock Bucket Shop of Outer Muskrat Falls” and you still have 80 seconds of “Go Slow” even after “Bob” gave you a “fill” at $40. So now that “$40” price prints on the tape and triggers some stop loss orders, that end up at Bob’s… and get $20, the $10, then …
For, you see, while the NYSE might have “buy orders” for 1,000,000 shares on the books at $49, $48, $47.50… the other exchanges only expect a deal volume on the order of 1/10th of that, or maybe even 1/100th … so just deflecting a minor percentage of the excess deal volume to them blows right through their $49, $48, etc. bids and hits the “crazy by I’m bored” orders of $20 or $1 a share. (Yes, I’ve put in “crazy but I’m bored” orders myself sometimes, never ever expecting them to be hit with a market order sell… but there was this one time…)
Basically, the whale pushed back from the table for all of 90 seconds, and the deal volume flooded elsewhere rather than slow down. Thus the cascade begins.
2) The “High Frequency Traders” pushed back from the table. These are the folks who do things like arbitrage the NYSE vs Pacific or Nasdaq prices. Or just pick off that “crazy $50 price on a $54 stock”.
So I’m the “P&G” monkey at Goldman. All I do is trade P&G. I’ve got my NYSE screen and my Nasdaq and my …. and suddenly I’m seeing “no volume on NYSE” and a Go Slow… So I hesitate for, oh, 5 seconds and pause my pushing of the “buy” key. That “at market order” bypasses my station (as it bypassed the NYSE) and heads for the next stop. And prints a $40 instead of a $50. Now I’m seeing NYSE “Go Slow” no BID, and I’m seeing (call it) a Nasdaq $4o print (and this is in the context of a hard down day after a few hard down days and Bad News Flow on Greece) and I just pull my bids while I take a minute to sip my coffee. One of MY rules about trades is “If you don’t KNOW what’s going on, STOP.” So these “high volume traders” push away from the table right as the $40 prints and sends a ton more “stop loss orders” in to a “sell at market” and with brokers that have a ‘few seconds’ trade guarantee….
Repeat until “Bob’s Pretty Good Stock Bucket Shop” is the only guy showing a “bid” for P&G (and that’s only because he had put up a “Buy 1,000,000 at a penny a share” when he took a coffee break before all the action started… and may not even be at his station (and yes, I’ve seen it done AND I’ve done it. ) But the computers are not as smart as the NSYE Floor brokers and they don’t know that the “Sell at market inside 2 seconds damn it” will not be happy with a 1 cent bid (and so the floor broker would not execute the trade); rather the computers just seek out the “fill” at the fastest speed for whatever is the bid. Period.
The bottom line is that we’ve built an unstable computer oscillator that works on milliseconds time and put a human hand on it that works in 90 seconds time. The inevitable result of this combo is an unstable collapse.
And now the “regulatory bodies” and the “exchanges” are trying to find someone else to blame, er, um, rather “are trying to find a way to prevent this in the future”….
I’d suggest having a single exchange be in charge of when a particular stock is ‘open’ or not (or “go slow” or not) and maybe, just maybe, having a little more respect for the value of a human on a brokerage floor…
Oh, and all of YOU can help by entering a “Stop LIMIT” order instead of a simple “Stop Loss” or “Stop Market” order. In a simple “stop loss” (sometimes called a ‘sell at market if touched’) you look at P&G at $54 and say “stop loss sell at $51”. That means if the price TOUCHES $51, sell my stock “At Market” for ANY PRICE that is on bid. No Questions Asked. If you enter a “Stop Limit” order, you say “stop loss sell at $51, limit $47” and that says “If the price hits $51, sell me out, but with a lower limit of $47. So if you can get $50.50, great, or even $47 go ahead, but at $46.99 it is just not a deal I want to do, so don’t sell. That’s just too cheap.”
If more folks had that kind of stop loss order in effect, the cascade failure would be less and the whole acceleration thing would have dampened faster.
And if nothing else, you wouldn’t feel like a chump for selling out at dirt cheap prices in a panic…
FWIW, I rarely use a simple stop loss order. I’m either driving my trades directly and “long hand” or it’s a stop limit order. I do it mostly just to force myself to ask the question “What price would I buy this stock at, no questions asked?” and “When is this a cheap enough stock I’d buy?” That’s my limit price. Why would I sell at a price where I’d be a buyer?
Oh, btw, part of the “cascade failure” was that as the indexes got knocked down from individual stocks on the NYSE having a ‘go slow’ and the deal volume running off to Bob’s… that caused a bunch of folks doing automated index trading to enter trades based on those index prices. That then drives the WHOLE body of stocks into the river with the NYSE stocks…. So folks running things like “Tradestation” (and most major houses have software to automate trades, even Schwab has a program) with buy / sell rules that you can program; started kicking out even more orders to sell as the downward trend hit the screens… So P&G takes a hit, that makes the DOW drop a little, that makes the TradeStation folks see a downtrend and dump DOW index, that takes the other 29 DOW stocks and starts selling them… they are also in the S&P 500, so it starts to sag, causing the SPY to drop, causing automated sell programs to kick in… repeat to the bottom.
Basically, there are no circuit breakers between individual stocks and ‘baskets’ any more. So once some stocks head down, the contagion to the whole basket begins. And where Mutual Funds used to only trade / settle at 5 pm when the markets closed, the Exchange Traded Funds ( the targets of many / most automated trade strategies) trade immediately and contribute to the deal volume and price movements.
There are a couple of more levers in this Rube Goldberg machine; but I won’t go into them here. Maybe on my blog in a day or two after the dust settles. They are not very important ones to the basic process anyway.