A man named Dan Sullivan, a former Chicago Mercantile Exchange floor trader, recently disclosed a manipulative experience. Sullivan bought and sold derivatives based LIBOR interest rate. Recently, Big Banks have been accused of manipulating the LIBOR rate. Back in 2008, Sullivan received a text message that indicated Lehman's was going under. Based on prior positioning with his derivatives, Sullivan expected to make one million dollars when the new LIBOR number came out the next morning. Knowing how the LIBOR figure is used and the likely collapse of Lehman, he was very sure of himself.
What happened that morning? The LIBOR number was mostly the same. There wasn't a significant increase or decrease. Sullivan was dumbfounded. In hindsight, it became clear - the banks had lied about the number. Many traders are suing because of the alleged deception.
Scott Patterson, Wall Street Journal report and author of the popular Dark Pools high frequency trading book, was recently interview by Brian Lehrer of NPR. High frequency trading computers are responsible for 60% to 70% of all trading today. As such, HFT trades make up the majority of the liquidity. These computers send in massive waves of orders to buy and sell futures, stocks, options, etc. Instead of humans handling orders, this incredibly fast pace has left regulators in the dust. While the markets are theoretically regulated by the FCC and CTFC, they lack the computing resources, manpower and funding to properly supervise.
Without regulation, you have manipulation. Let's say Greece defaults and a big move in the currency markets results. The high frequency algorithms will see this occur and positions will immediately change. When high volatility occurs, the HFT systems are able to pull out. Because of the liquidity caused by HFT, the markets would grind to a halt. Look up "splash crash" to see what researchers say about this hypothetical scenario. Sure, regulators could say that the HFT systems cannot pull out during a crisis, but again, this is a complex enforcement issue.
We will now look at a third manipulation scenario. Major news events and company press releases can greatly affect financial markets. This results in instant volatility across the world's most popular stocks, futures and currencies. Laws and policies are in place to prevent this type of information dissemination. What happens when an insider lets a trading friend know the Apple third-quarter profit figures prior to the public announcement? This trader friend can now place trades anticipating the financial reaction. This trader can also share this information with others. To leak, only a few seconds are required considering the speed at which we are able to communicate today. There are many hands announcements must pass through before they become public knowledge.
Retail traders, those who trade from home as a hobby or as fulltime income, are also at risk when it comes to manipulation. These traders must be aware of the instability imposed by high frequency trading. Humans looking to position themselves within a fast past world of automated, algorithmic buying and selling should consider a trading education. Such training teaches strategies that recognize manipulation and work alongside it.
High Frequency Trading is here to stay. Even though governments may improve trade monitoring technology, the speed at which automated systems develop far outpaces the cumbersome paradigm. Sure, governments recognize how HFT have become intertwined and necessary function of electronic trading.
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