The stock market / commodities market / bond market stopped making any sense to me about 6 years ago and I am pretty sure it is due to Robo Traders (aka high frequency trading algorithms).
These robots have forced the general stock market higher and commodities lower.
The big problem is that by jamming the “”markets”” ever higher, the central banks have created an enormous gap between current prices and reality.
An easy to see example of this is the housing market in San Francisco, where average income earners cannot afford average houses — at all. The only way the SF housing market can re-balance to a sustainable level is either for salaries to shoot up massively (while house prices remain flat) or for house prices to fall.
Equities are no different; their prices current suffer from a similar “reality gap”. The same is true for bonds.
The High Frequency Trading computer algos are in complete control of the “”market” action, and play with and off of each other to create massive sudden price movements that have nothing to do with anything except order saturation.
Here is just one tiny recent example of the oil market on the NYMEX:
Starting around 6:30am, oil futures started drifting slightly lower. A little volume came in around 6:40 a.m. and then — BAM! — right at 6:44 a.m. EST, a super spike of volume to the downside occurred. But in 3 seconds it was over. (These are one minute bars so those three seconds are obscured in a full sixty second long bar).
So…8 thousand contracts sold in 3 seconds.
The point being, these volume spikes (especially to the downside) have an intensity that is simply overwhelming for the market structure.
Which is entirely the point of the operation. That’s the very essence of price manipulation.
Let’s try to look at this rationally. Let’s define intensity as “volume of more than 2 standard deviations above the recent 1-hour average, divided by the duration of the volume event.”
If we do this, an analysis of the oil chart above would go like this:
Say the average volume was 200 contracts/min. The normal ‘intensity value’ would be 0, because there are no moments above 2 std before the big volume spike (0/0)
Making a guess of a std of 300 for the normal period, at the height of the spike, the value would be ~7,400. Then divide the 3 second episode (expressed in minutes) and you get 148,000.
So from an intensity value of 0, thing spiked up to 148,000 in a matter of seconds.
And it’s that super out-of-range characteristic that just clobbers the price of whatever is being traded (in this case oil, one of the most widely-traded commodities on the planet).
These blasts destroy the market bid/ask structure in those moments. You have literally zero chance of trading that event as a human, even and especially if using ‘insurance’ like automatic stops.
This means that the “”markets”” have a barrier to entry where the cost is the price of a very expensive arrangement of hardware and software capable of operating at the micro-second level. Humans need not apply.
The markets now belong to the big players (aka big banks and hedge funds) and their very expensive machines.
And they are controlling the market with sudden spikes in volume that basically destroys the current market price and the future market price all with a 3 second slam.
And the reverse is done with the general stock and bond market. Perfectly timed buying spikes soak up supply.
How can a little 3 second selling blip in oil contracts control the entire market price you ask?
Imagine that you are selling eggs at the farmers market along with nine other vendors. There are 500 people wandering the market looking for eggs and other produce. The average sales rate for all 10 egg vendors and all 500 customers is 5 dozen eggs per minute.
The price you can sell your eggs for is set in accordance with the other prices around you. Yours are organic, but small. The vendor next to you has large eggs that are conventional, but larger. And third has small colored eggs from heritage breeds that are free range. Let’s say that the range of selling prices is from $4.00 per dozen to $5.50 per dozen. This is the price for eggs at our farmers market set by supply and demand in the free market in this exercise.
All of a sudden, a giant semi-truck backs up. It’s filled with eggs matching every description of those being sold at our small little market. A bullhorn speaker rises from the roof of the truck and announces that 10,000 dozen eggs are now available for the next 1 minute for whatever price anyone is willing to give him for them, but only for one minute (they want to be in an out before anyone has a chance to ask too many questions about where these eggs came from).
What do you think happens to egg prices over that one-minute window? That’s right, the price gets completely crushed. And what do you think happens to demand for eggs among the 500 potential customers at our market? It’s completely satisfied. So future demand is eliminated and sales volumes decline accordingly.
People are throwing change in their pocket at the semi-truck and grabbing all of the eggs they can carry.
In other words, the “”market”” for eggs got ruined, right there and in an instant. You and the other 9 original egg merchants got thoroughly hosed. you all packed up your eggs and went home because the volume of eggs on offer shot up massively all of a sudden, but once all 500 potential egg buyers had been satisfied, the number of buyers dropped away rapidly. Liquidity dried up.
This shows how it’s possible to have a market with tons of volume, but no liquidity. For the rest of the day there are lots and lots of eggs for sale, but no buyers. And with lots of supply but no demand the price keeps dropping until an equilibrium is met.
That one minute spike controlled the current price and the future price (at least for a few days in the egg example).
The point here is this: The high frequency computer bots now are the market.
They operate according to a set of pre-programmed parameters. If or when those parameters are exceeded, they simply vanish in less than an eye blink. When that happens, prices go wonky as the remaining few algos go wild. Their resulting erratic trading spikes volumes and prices all over the place.
Why This Matters
Maybe you’re thinking, “So what?” Maybe you aren’t a trader and think the hows, whens and whys of the computer algos in the Brave New Market isn’t really of any concern to you.
But it really is. And here’s why.
By virtue of its existence, we know that central banks have these bots and are are highly active traders on these exchanges.
Not one single central bank (yet) reports anywhere in their financial disclosures of being the proud owners of any of the accounts traded on the exchanges. So the details of the situation remain a mystery.
But dependably, every single market decline that began over the past several years has been reversed — usually in the dead of night, and in the futures market — by mysterious injections of capital that then get the HFT algos to follow the trend.
And the Fed is fighting any sort of audit tooth and nail.
The big issue, however, is what might happen if (or rather when) things get ‘out of hand’ and the computer bots cannot be cajoled back into the market because the parameters are just too far out of whack. ‘A major market accident’ is the likely answer.
From Dave Fairtex:
Two weeks ago I went to this lecture by a guy (a physics PhD) on unsupervised machine learning techniques called “reinforcement learning”. In the past, the lecturer had worked for JP Morgan and others on HFT applications. He’s now got this startup, and he was (more or less) recruiting AI/ML people to come work for him.
One interesting question was asked by an audience member: “how do you train your bots for market problems or exceptional conditions?” His answer, informed by years of work in constructing market maker bots, was: “the vast majority of time is spent in ‘normal markets’ and as such, that’s how we train our bots.” Basically, when things get dicey, they just turn them off. I’ve heard that before too, but it was fun hearing it from the horse’s mouth.
And, of course, that’s why we have flash crashes. Also my sense is, there aren’t really enough humans left to make markets in an emergency, since the profits have been all eaten up by the bots – no money to pay the human traders, which would spend 99.5% of their time sitting and looking at the bots doing their work. And the bots have only been trained on “normal situation” operations.
It makes sense. Why train a bot for exceptional situations, when a huge pile of money can be made just on the day to day fluctuations. Not only is finding enough data to train a bot to run during crash situations difficult, testing is problematic, and then of course you have to wait for a crash and see if it actually works. And if there’s a bug, losses could be catastrophic. Better to pull the plug when things get iffy.
So, why does this matter to you? Because today’s “”market”” structure is so completely broken now that a flash crash can happen in any sector, no matter how large. That’s not speculating, that’s established fact.
Once a crash really gets under way, for whatever reason, getting the computer bots back online cannot be accomplished until and unless the markets are within certain operating ranges. That’s just how they are built and designed. So as long as everything is within a certain set of parameters, the bots will participate. But as soon as they aren’t, they’ll all just disappear. When they do, they’ll take literally 99% of the market quotes away and 70% of the trading volume. In an instant.
Someday parameters will be exceeded and the “”market”” will crash. Unless the central banks can manage to become such dominant buyers in the “”market”” that they become the market. Japan’s central bank has already achieved this status in its country’s government bonds and ETF markets.
Who knows? Maybe this is the goal of every major central bank. But if so, then we should be having a robust discussion about how this is no different than printing up money and handing it directly to the very wealthiest individuals and most powerful corporations.
That’s not monetary policy. That’s social engineering.
Who wants to figure out how to satisfy all those state and federal regulations involved in opening a new business when you can earn more by playing the speculation game in the financial “”markets””?
As Adam Taggart wrote recently:
When [the market correction eventually] happens, those who decided to look like an idiot early on and refuse to join the party (i.e., positioning their capital defensively), are going to look like geniuses. They will avoid the heartbreak of loss, and they will have capital to deploy when the dust settles, purchasing quality assets at (potentially historic) bargain prices.