Monday, 19 February 2018

The market factory: things that make you go hmmm

This little meander is just a catch-up on things that make me go, "Hmmm."

A belated HFT St Valentine's thought first:
Heatsinks are red
Packets race through
Bits don’t worry
Neither should you

CME Canaries


Via the WSJ, Quantlab started a very public war with CME and some other traders, likely to be other HFT firms, who have been enjoying the suffocation of canaries as meandered here, "Killing canaries.

With ten percent of trades having two milliseconds of delay in the market data feed, Quantlab has a good deal of right on its side.

Unfortunately, for avian-friendly traders at CME, Quantlab's representation in the WSJ was a bit wrong. The delay is more than twice as bad as reported. Or twice as good if you like killing canaries.  Quantlab posed to twitter more pertinent statistics,



That is quite the problem. At 5,093,000 nanoseconds of canary, Alexandre Laumonier, aka SniperInMahwah, pointed out - though with terser language - you can get a canary, package it up, transport it from Chicago to your choice of data centres in New York, New Jersey, and Mahwah, execute a trade, all whilst pouring a cup of coffee, and other participants at CME don't yet know the market price has changed.

I don't have a problem with little canaries. The canaries are natural and all exchanges used to work this way. A canary may be thought of as a technological rebate, as compared to a price making rebate, where you get a little advantage for making a market. You may argue for and against. Especially as there is a little more to the story that an HFT may not disclose. You know, secrets. We have to make a living.

Many exchanges are moving to a "public first" position, but I reiterate, having small canary effects is not an evil in itself. A friendly punch in the arm in jest is OK. Giving someone a black-eye is not so great. 5,093,000 nanoseconds of canary is also not OK. IEX remains the worst exchange as they purposefully notify all other co-lo facilities of all trades before their own customers.

I added an addendum to the previous meander noting that the wise Mr Sam Tyfield noted that under EU regs canaries on both lit and dark venues may be termed "phishing" and would be improper unless you documented your lack of intent in a valid trade plan. To not do so would be to invite risk. Mr Tyfield also contributed a nice poem for St Valentines day:
Canaries are contentious
Feelers are too
And if you want to know book depth
No intent is the clue
It seems to me that we all owe thanks to Quantlab for raising this debacular debate. The momentum is certainly swinging toward freeing canaries from market mining cages.

Canary latency is one of those things that should make you go, "Hmmm."

EMSAC


My meandering mind had mixed thoughts around the disbanding of the Equity Market Structure Advisory Committee (EMSAC) in January just as the first Fixed Income Market Structure Advisory Committee (FIMSAC) met.

My first thought was that there is plenty still to do with respect to equity markets. So, why disband? However, as I noted in "U.S. Equity Market Structure Part I: A Review of the Evolution of Today’s Equity Market Structure and How We Got Here," it seemed a futile body with little consensus, competing agendas, and the dialogue often appeared a little irrational. Themis Trading's Mr Joe Saluzzi was an unusual EMSAC inclusion due to Themis Trading's tiny size, his pronouncements being a little weird from time to time, and also as he is prone to shoot from the hip without enough reflection. All qualities that may similarly dismiss consideration of myself from such a post ;-) For example, Mr Saluzzi was reported in the FT saying that the IEX rebate cleverly disguised as a rebate was not a rebate and it was only applicable to principal order flow, in opposition to IEX's clear documentation:

Not an isolated incident.

In the last EMSAC, IEX's Mr Brad Katsuyama made some rather offensive, ridiculous, and wrong statements about price-providing rebates which I discussed here, "Rebate trafficking." As many know, I'm not a fan of IEX's ridiculous posturing. The evil Dark Fader exchange preys upon others' good price discovery work by subverting market efficiency whilst ripping their clients with ridiculously high transaction fees as they send canary-like advance notifications of their clients' trades to Nasdaq and NYSE in advance of their own clients whilst denying their clients the fairness of a colocation environment. Ahhh, that feels better. As a public exchange, IEX sux. You should go, "Hmmmm."

However, the "other side" at EMSAC could also be found foot faulting. I'm generally supportive, admiring even, of Global Trading Systems and the work of Mr Ari Rubenstein. Pushing his agenda as a designated market maker, Mr Rubenstein argued for his vested interest and against the introduction of closing auctions at other exchanges, specifically at CBOE/BATS. That is not very defensible. Such competition is healthy. It is not quite as simple as more competition is better as there are complications around having multiple closes, but it is nevertheless an obviously good move. It goes to the point that EMSAC was a little dysfunctional. The committee format really does nothing that can't be done by canvassing various types of market stakeholders at a leisurely pace. At least the SEC took the sensible path and alternate market closing auctions are now a thing.

EMSAC's dysfunction was also highlighted to me by Instinet's Mr John Comerford's presentation. He had the most obvious and uncontroversial proposal. There is an undeniable economic argument which Mr Comerford succinctly laid out: market tick sizes should be variable. The market microstructure economics are fairly clear and beneficial. There is a general consensus around this issue with Nasdaq certainly supporting this too. Mr Comerford came to the committee with this small and uncontroversial idea quite cleverly trying to bypass contentious issues that had little chance of traction. This variable tick idea is a market aspect that should be a reasonable and straightforward thing for EMSAC to get behind. It seemed, to me, to be simply drowned out by the surrounding noise as little has been done. If EMSAC couldn't push forward something so simple at the SEC, being disbanded is a reasonable outcome. It will be interesting to see if FIMSAC is also broken.

It certainly seems the SEC needs to rely more on its own analysis and make decisions by ignoring the noise where sound economic arguments and clear public interest exists. Seek counsel, advice, comments, but not consensus. That's a thought. Hmmm.




Show me the data


The common refrain, "show me the data" is often used in a market debate to shut down the other side's argument. This is a line that is often valid, but equally makes me go, "Hmmmm."

We have strong economic and financial theories which often need little debate for particular circumstances. If you prove mathematically A + A = 2A you don't need data to reassure you. The standard for when data is or is not required is quite the fuzz in markets. We should all be aware that the "show me the data" mantra is often just harmful.

It reminds me of the common open source refrain to someone pestering you for fixes, "you have the source, send me a patch." Sometimes that is an honest wish, but more often it's just a successful way of shutting down debate. You know you'll never hear from them again.

In data we trust. Except when you see your first black swan with white tipped wings in the river by my house in Huonville. I'm not sure Taleb has seen this variety but he would not be surprised. Inductive hypotheses with misconstrued incremental steps can be dangerous with data too. Data sometimes misleads us. Data often confounds us with concurrent experiments, policies, phases, reactions, assimilation, adjustments, and experiential learning feedback contorting us to consider it may be turtles all the way down. Such data review may be as useful as observing that popular butterfly's wings for distant tornado prediction. It is difficult repairing aircraft whilst they fly. 

I like to look at data, but I don't always need it to know what is right. Too often it's a crutch. Next time when someone challenges you with, "show me the data," don't dismiss the call, but do go, "Hmmmm."

Market data fees


IEX is a public parasite that deserves to be kicked back into ATS land where it belongs. One good thing IEX does, however, is offering a rebate to all of its market participants in the form of free market data. IEX has a lot of rebates for an exchange that offers no rebates. Such a rebate is to be commended. It is not necessarily the most useful market feed as, being a little lame, IEX participates rarely at the NBBO, but this market data rebate is unequivocally good. 

"In 2008, two years after becoming a public company, NYSE began increasing fees for non-core data and the other exchanges quickly followed suit. Despite SIFMA and others expressing concern about these fees, the Commission has allowed the exchanges to continue raising prices on proprietary market data, thus allowing market data to be a primary source of income for the exchanges. Exchange revenues in 2016 were driven by a 29.2% increase in market data revenues to a total of $5.4 billion."
Being such an important part of exchanges' income, market data fees are a controversial issue for exchanges.  BATS offered free market data at its inception. Eventually BATS started charging participants for the service. Mr Dave Cummings, BATS founder and ex-CEO, has publicly expressed disappointment in BATS choosing to charge for market data.

Often participants complain that it shouldn't be right that exchanges are just selling them their own data back to them. I kind of enjoy that argument. It brings a smirk. But, it is not a valid argument. It is a bit like the atom defence in patent litigation that nothing should be patentable as it is just rearranged atoms and we know all the atoms. There is value in the aggregation, processing, and careful delivery of market data.

A big unaddressed problem with market data is the demand curve being somewhat inelastic. Every significant participant needs to subscribe to all feeds. Exchanges are free to foist fee enrichments with little recourse. If you want to be careful in fulfilling your best execution obligations in real-time, you need the data. There is not much choice. The rises, product differentiations, complex pricing schedules, and sometimes onerous volume levels serve little good. Even though the various SIPs' latencies have vastly improved, there is no substitute for direct feeds.

Due to such inelasticity and island monopoly behaviours, the regulator needs to regulate here. Market data is more a utility than a luxury. Some people may think, "If only we had a committee to look at this, we could call it something like the Equity Market Structure Advisory Committee." Personally, I think the SEC should just do its job. If it is not smart enough to do it, it should get smarter, but we know it is smart enough. It seems just a little less active than it should be. Perhaps the SEC is hampered by the new laissez-faire mood surrounding all regulators which may be being driven from the top.

Market data is a mess. Fix it, SEC.


HFT kangaroo loose in my top paddock?


Global warming has thawed some pundits' HFT frost. This is definitely one of the nicer things that made me go, "Hmmmm."

Frequent HFT critic and maverick Maverick, Mr Mark Cuban, acknowledged an investment in Virtu as a proxy for volatility. Though this has to be tempered with the idea that he was joining a firm he saw as advantaged rather than changing his mind too much about HFT. Bloomberg wrote in "Mark Cuban Once Trashed Speed Traders. Now He's Investing in One,"
That’s a turnaround from March 31, 2014, the day Michael Lewis’s book “Flash Boys” came out, in which he blasted high-speed traders. “There’s no such thing as bug-free software,” Cuban said that day in an interview on CNBC, calling it the greatest risk to that type of trading. “When you have fat-finger bugs you just don’t know what’s going to happen to the market.”
Bloomberg's Barry Ritholtz's change of stance was more of a change of stance when he reflected, "How committed are you to a belief system?" in the opinion piece, "One Question Investors Should Ask Now and Then - The answer might reveal flaws in your thought processes,"
High-frequency trading: I have been a pretty robust critic of HFT, based on the premise that trading is a zero-sum game. Whatever profits the HFT traders extract are coming out of slower-speed trading accounts. Sniffing out trades before they are executed and jumping ahead of them sure looks like front-running, which in the traditional sense is illegal. I don't know if this variant is illegal, but it sure seems wrong. 
My views on this have been moderated by (of all things) Vanguard Group Chairman Bill McNabb (interviews here and here). McNabb has made a fairly credible case that HFTs make it easier and cheaper for giant shops like his, which has about $5 trillion under management, to execute orders. It required a rethink of how the firm approached trading, but in the end it seems to be money-saver for a company that tries to pass on low costs to clients who are doing things like saving for retirement.
Even as Mr Ritholtz makes a concession, he includes a bit of a flawed thesis, on which the respected, Mr Adam Nunes commented via twitter,

Mr Nunes is so very right. This is a misconception I've been fighting since the newly appointed BT CEO, Mr Frank Newman suggested closing various IB businesses in the 1990s, including my prop trading group, Capital Markets Group (CMG). He suggested there was no point competing in zero-sum games. After the crowded lift failed, getting hot and sweaty as the minutes ticked by, I was wheeled out to choke a little infront for Mr Newman. I did spit out my prior approved question at the all-staff gathering to challenge his view on zero-sum. It was a young twenty-something to the slaughter. I still have nightmares about this wee little public choking and humiliation, but the point was made. Zero-sum begone.



Prior to the "Flash Boys" novella, I meandered about "markets are a zero sum game" being the biggest myth in all of finance, "Hedging – losses as profits that feed traders." Sometimes you have to count your wife's teeth.

Hmmm.

Crypto-currency crime


Bubbles come and go. Meh. Being libertine at heart -  even though the libertine part seems to be shrinking with age - I'm disturbed by my disturbance at the marketing around so-called virtual currencies. Octogenarian family friends, who can't use an iPad, make enquiries about BitCoin. I suspect you, as a knowledgeable technology or finance peep, have been asked similar questions even if you are no longer reading this all too long meander.

If you are no longer reading I presume you will still know if you've been asked about such coinage - despite the breaking of the fourth wall. It is a worry that the National TV News from the public broadcaster here has had BitCoin prices and commentary in the nightly finance report for many months. Crazy stuff for something with the mirage of the modest market cap of a single stock. When remote Tasmanian retail, or the shoe-shiner, asks about Bitcoin, you know you have a retail problem that needs some unfortunate regulatory consideration.

I wrote a child-like meander about crypto-currency and crime last week, "Your crypto-currency response will be weighed." It serves little purpose other than as therapy but I enjoyed the music. The important aspect is to realise, according to the UN, there are some 40,000,000 modern slaves in the world and they deserve their AML back. There are kids being abused and photographed with their pictures being hosted on servers paid for with BitCoin.

Yep, slavery is still a thing:




My musing meandered me to the point of view that crime may destroy BitCoin before other factors, say bubbles. The regulators have been asleep at the wheel. Perhaps with its minor transaction flow profile virtual currencies didn't deserve too much attention, but the genie escaped that bottle years ago. The regulators could have nipped this nightmare in the bud with some pretty simple regulations. They failed their mission.

Most disagreed with this point of view in comments sent back, though I appreciated some support. I'm hoping this is another Søren Kierkegaard moment where my minority view may be right.

Society has a point. There is a minor fraction of real currency that is laundered. There is a minority, perhaps a much bigger minority of virtual currency that is likewise laundered. For the non-virtual case, we've developed some pretty flawed regulations and laws in a ham-fisted attempt to stem such criminal activities. They have a point as the best we can do for now. The same regulations should be equally applied to virtual currencies.

Money laundering is a pretty big deal,

(Sourced from PWC - click to enlarge)

unless you think $2 trillion a year is nothing to worry about.

I've been especially critical of the CFTC's and SEC's tepid response. That seems to be changing as they ramp up the rhetoric to counter their embarassing lack of action. See this sensible Written Testimony from the last week by Chairman J. Christopher Giancarlo. There is a lot of good work in there, including this piece on virtual currencies,
VIRTUAL CURRENCIES
Let’s turn to virtual currencies. Emerging financial technologies are taking us into a new chapter of economic history. They are impacting trading, markets and the entire financial landscape with far ranging implications for capital formation and risk transfer. These emerging technologies include machine learning and artificial intelligence, algorithm-based trading, data analytics, “smart” contracts, and distributed ledger technologies. Over time, these technologies may come to challenge traditional market infrastructure. They are transforming the world around us, and it is no surprise that these technologies are having an equally transformative impact on U.S. capital and derivatives markets.
Supporters of virtual currencies see a technological solution to the age-old “double spend” problem – that has always driven the need for a trusted, central authority to ensure that an entity is capable of, and does, engage in a valid transaction. Traditionally, there has been a need for a trusted intermediary – for example a bank or other financial institution – to serve as a gatekeeper for transactions and many economic activities. Virtual currencies seek to replace the need for a central authority or intermediary with a decentralized, rules-based and open consensus mechanism. An array of thoughtful business, technology, academic, and policy leaders have extrapolated some of the possible impacts that derive from such an innovation, including how market participants conduct transactions, transfer ownership, and power peer-to-peer applications and economic systems.
Others, however, argue that this is all hype or technological alchemy and that the current interest in virtual currencies is overblown and resembles wishful thinking, a fever, even a mania. They have declared the 2017 heightened valuation of Bitcoin to be a bubble similar to the famous “Tulip Bubble” of the seventeenth century. They say that virtual currencies perform no socially useful function and, worse, can be used to evade laws or support illicit activity. Indeed, history has demonstrated to us time-and-again that bad actors will try to invoke the concept of innovation in order to perpetrate age-old fraudulent schemes on the public. Accordingly, some assert that virtual currencies should be banned, as some nations have done.
There is clearly no shortage of opinions on virtual currencies such as Bitcoin. In fact, virtual currencies may be all things to all people: for some, potential riches, the next big thing, a technological revolution, and an exorable value proposition; for others, a fraud, a new form of temptation and allure, and a way to separate the unsuspecting from their money. 
Perspective is critically important. As of the morning of February 12, the total value of all outstanding Bitcoin was about $149 billion based on a Bitcoin price of $8,800. The Bitcoin “market capitalization” is less than the stock market capitalization of a single “large cap” business, such as Disney around $156 billion. The total value of all outstanding virtual currencies was about $430 billion. Because virtual currencies like Bitcoin are sometimes considered to be comparable to gold as an investment vehicle, it is important to recognize that the total value of all the gold in the world is estimated by the World Gold Council to be about $8 trillion, which continues to dwarf the virtual currency market size. Clearly, the column inches of press attention to virtual currency far surpass its size and magnitude in today’s global economy. 
Yet, despite being a relatively small asset class, virtual currency presents complex challenges for regulators. Chairman Jay Clayton of the U.S. Securities and Exchange Commission (SEC) and I recently wrote: 
The CFTC and SEC, along with other federal and state regulators and criminal authorities, will continue to work together to bring transparency and integrity to these markets and, importantly, to deter and prosecute fraud and abuse. These markets are new, evolving and international. As such they require us to be nimble and forward-looking; coordinated with our state, federal and international colleagues; and engaged with important stakeholders, including Congress.
 It is this perspective that has guided our work at the CFTC on virtual currencies. Our work has six broad elements: (1) staff competency; (2) consumer education; (3) interagency cooperation; (4) exercise of authority; (5) strong enforcement; and, (6) heightened review of virtual currency product self-certifications.
The interagency mess is quite troubling. Self-certification is also troubling in this domain. We have the various SROs, SEC, CFTC, FinCEN, FBI, DOJ, FSOC, FSB, IOSCO all with a stake.

We have to be careful with our technology and regulations. Just because cameras are used for kiddie porn, we don't ban cameras. Similarly, mathematical truths and cryptography are too important for the good of humanity to limit or ban. The FBI and NSA are not too happy with solid cryptography being used in the wild. Shame on them. As a society, we have chosen another path. We choose to use society's lubricant, money, as one of the primary mechanisms to keep our children safe and to act against slavery. This, to me, remains a valid choice. Virtual currencies are subverting this due to a lack of oversight.

The docile and inactive FinCEN at least prosecuted the $4B laundry-o-mat that was BTC-e. A $110M fine was levied. Part of the case included highlighting not only the problem of bitcoin mixers but the clear and present danger of newer virtual currencies that provide untraceable features. Dash in this case:


With many next-generation coins, such as Zcash, and then Monero, improving on the usefulness of virtual currencies for crime, we need to wake up and process this nightmare that refuses to sleep. It is not possible for me to accept that Monero should be available for any reasonable transaction size given the impossibility of AML/KYC application to such a beast.

Australia introduced new virtual currency laws recently but a punter can still buy Monero at exchanges touting AML compliance. Many buy BTC at Coinbase and then convert to Monero.  It would seem there needs to be a central body or regulation that has viral properties. You can't expect global rules to be negotiated or exist - certainly not in a timely manner. A viral approach where you can't transact with a non-member or a non-compliant body is the only workable solution. A cabal of countries agreeing would be better, but the US or the EU could go it alone if necessary, again.

A further step would be for compliant venues to raise a Suspicious Transaction Report requirement for coinage going to non-compliant venues or being tumbled. It is right there in the chain and popular addresses are known or derivable. That is somewhat better than cash in that you can track the trackable, but not the new generation of crime-based coinage such as Monero. The viral possibilities in such an approach are better than what we have with cash. There is hope.

It does make you wonder if there is a grand conspiracy in that Bitcoin may be a long game where the US government is trying to corral all the criminals into a tight space where one sucker punch will bring many undone. Alas, government incompetence and Hanlon's razor makes this unlikely. Yet, it makes me go, "Hmmm."

Virtual currencies are a cesspool that need not be so. Regulators are belatedly picking up the ball, but not fast enough. ICOs and the vulnerability of poorly educated retail are one dimension but I worry more about crime. You should too. This is a thing that should make us all go, "Hmmm."


CATastrophe


It was useful that the CAT provider, Thesys Tech, restructured to reduce conflicts. However, the CAT remains weirdly flawed. Not because of Thesys. The specification is just wrong. Not enough people care about this suggesting people are happy for it to fail in its mission even though it may succeed in its rollout. It's like saying a dingo is the perfect boomerang. CAT fees for nothing is a tiny bit disturbing. I doubt Mark Knopfler would be surprised:
Now look at them yo-yo's that's the way you do it
You play the guitar on the MTV
That ain't workin' that's the way you do it
Money for nothin' and chicks for free
Now that ain't workin' that's the way you do it
Lemme tell ya them guys ain't dumb
Dire Straits indeed. I maintain my old view on this described here, "Crazy CAT approved by SEC." It's absurd. This makes me go, "Hmmm."

Market volatility and value


One normal version of our parallel universe's VIX resuming escalated sedation:



What could possibly go wrong:

Valuations continue to make me go, "Hmmm."


IEX


It exists as a public exchange. That makes me go, "Hmmm."


Arms carrying arms


Since Sandy Hook, the USA has showed it can't fight its way out of a wet paper bag, or Congress, without a gun. That makes me go, "Hmmm." You need more data? Show who the fu*king data? Well, I guess you now have more fu*king data.

(click to enlarge)
The intention of the Second Amendment to do various things seemingly includes enabling state militia to overthrown a central government. How can they do that with a wimpy AR-15 with or without a bump-stock? Shouldn't cruise missiles, nukes, Mach 2+ fighters, stealth bombers, tanks with uranium tipped munitions, powerful explosives, rocket launchers, 50mm Gatlings, rail guns, patriot missiles, et cetera, all be available for all? Why the restrictions? How can the government get away with denying such obvious Second Amendment rights? How are you going to overthrow the Goliath that is the US government without powerful enough slingshots?

It's a haunting hypocrisy.

Australia used to have one to two mass shootings a year for a very long time. Roughly one every eighteen months. Then a retiring NSW realtor and his wife bought my parents' ten-acre hobby farm at Crabtree in the Huon Valley. Finally a peaceful retirement. The retired realtor's wife took his beemer and visiting guests down to the quite quiet and lovely Port Arthur for a scenic day out. His wife and guests were killed and one poor soul was bundled into the beemers boot as a coward killed thirty five people. The coward viciously hunted the very young daughters of a chemist. One daughter, Madeline, three years old, was lined up, point blank, against a tree as she tried to hide. Her mother was fortunate, in an awkward respect, to have not survived long enough to suffer the visions that haunt Madeline and Allanah's father.
John Oliver's series on gun control: Part One. Part Two. Part Three.
A gun buyback ensued. Twelve or so weeks of debate and legislation passed quickly even though a 'C'onservative government was holding court federally. How many mass shootings in the last twenty-two years, in total?

Zero.

That should make us all go, "Hmmm."


Hmmm,

--Matt.

Thursday, 15 February 2018

Your crypto-currency response will be weighed

The SEC and CFTC have been negligent in their slow and limited responses to coins, alt-coins, and ICOs.
There's a sign on the wall
But she wants to be sure
'Cause you know sometimes words have two meanings
Financial institutions have been negligent. Robinhood has been surprisingly negligent. Fintech, new and old, have certainly heeded the pipers' piping.
Your head is humming and it won't go
In case you don't know
The piper's calling you to join him
It begs the question, can the SEC and CFTC be sued for their negligence? Are they immune? Can they be held to account? Are the staff who are meant to be enforcing the rules immune? Who is asleep and not watching the watchers?
And as we wind on down the road
Our shadows taller than our soul
There walks a lady we all know
Who shines white light and wants to show
How everything still turns to gold
If such products are not securities, they would surely be at least security-based swaps requiring regulatory oversight. Just ask Forcerank LLC for an opinion.

The Commodity Exchange Act defines a swap thus,
“[T]he term ‘swap’ [includes] any agreement, contract, or transaction—… (ii) that provides for any purchase, sale, payment, or delivery (other than a dividend on an equity security) that is dependent on the occurrence, nonoccurrence, or the extent of the occurrence of an event or contingency associated with a potential financial, economic, or commercial consequence[.]”
There will be a reckoning.

Fast bucks. Short-cuts. "In every home a Big Mac. And no one goes outback, that's that."

Fake understanding. Ransoms. Theft. Black-markets. Blackmail. Dodging governments. Hacking. Theft. Scams. Tax fraud. Corruption. Gambling. Extortion. Slavery. Child labour. Tipping terrorists. Funding fakes. Paying paedophiles.

Emperor's clothes.

If criminal enterprises were to try to design an effective money laundering machine, how could they design something better than crypto-coinage? In the words of the great Led Zepplin,
"Ooh, it makes me wonder."



"Ooh, it really makes me wonder"
The supply of finite parcels of infinite species is endless in this Hilbert Hotel. It's not so scarce as to avoid the laws of oversupply and limited demand. The limit of 1/$ as $ follows Buzz Lightyear to beyond, is zero. You may not always have a fiduciary responsibility, but you have both an ethical and moral responsibility cojoined with a simple responsibility to care.

Some banks have been tightening their transactional interfaces, mainly via credit-card restrictions. It is hard to see how any institution that interfaces, however direct or indirectly, to such criminally criminal infested criminal products of crime are complying with their AML (anti-money laundering), KYC (know your customer), and CTF (counter-terrorism financing) requirements. The rates of illegality, lawlessness, tort, and outright criminality in crypto-coinage are such that if you touch it without complete knowledge, which is virtually impossible, you are tainted.

You are tainted.

Even Robinhood's limited restrictions and attempts to hide their AML/KYC/CTF compliance behind indirect coin provisioning is simply a shoddy front. Robinhood's scheme may even be strictly interpreted as furthering money laundering by providing an artifice of indirection in an attempt to legitimise their greed in guzzling crypto-chasing commissions.
And it's whispered that soon, If we all call the tune
Then the piper will lead us to reason
And a new day will dawn
For those who stand long
And the forests will echo with laughter
The limited and growing reaction from financial institutions may also be generously interpreted as growing realisation of guilt. Just asking for a future class action?

There will be a reckoning.
Yes, there are two paths you can go by
But in the long run
There's still time to change the road you're on
And it makes me wonder
There is no free lunch. It's not just the corporations at risk. Employees are at risk. Boards are at risk. Who wants to be on the front page enabling terrorism and paedophilia?

Does anyone go to gaol?
If there's a bustle in your hedgerow
Don't be alarmed now
It's just a spring clean for the May queen
Yes, there are two paths you can go by
But in the long run
There's still time to change the road you're on
There will be a reckoning.
Sometimes all of our thoughts are misgiving
Yeah, that's what I really think,

--Matt.

______________________________________


"But in child abuse networks, there is much less money in circulation" ... "All the same, it costs money to have a website hosted on a server. In this case, payment was rendered in Bitcoin, a virtual currency."

______________________________________

"Beware the risks of virtual currencies posing modern slavery"


______________________________________

"Virtual currencies...are increasingly being used by serious and organised crime groups as they are a form of currency that can be sold anonymously online, without reliance on a central bank or financial institution to facilitate transactions"

______________________________________

CEO Magazine, "Will crime be the end of Bitcoin?

The monetary system hailed as the ‘world’s first cryptocurrency’ might be brought crashing down, not by market speculation but by crime. "


________________________________

Bloomberg, "The Criminal Underworld Is Dropping Bitcoin for Another Currency"


________________________________

Cryptocurrency like bitcoin is easy money for criminals

"Bitcoin and its brethren have earned a reputation for fast returns on investment, but they're vehicles for exploitation too."

BY ALFRED NG, FEBRUARY 14, 2018 5:00 AM PST

"The connection between cryptocurrency and crime is only going to get worse as investments continue to boom."

"Holland predicts that it'll be five to 10 years before governments can get a handle on digital currency crimes, and even then it may not be possible. That's because the schemes will just evolve."
________________________________

Criminals in Europe are laundering $5.5 billion of illegal cash through cryptocurrency, according to Europol

______________________________


The Washington Times, "Military, intelligence agencies alarmed by surge in bitcoin value in ‘dark web’ fight"

"This summer, the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN), the Department of Justice and scores of European illicit finance law enforcement officials have fought back with a wave of operations against Russian cybercriminals. Late last month, they shuttered AlphaBay and Hansa — two of the biggest “dark web” contraband marketplaces rife with the illegal sale of guns, drugs and other forbidden merchandise.
In an even more startling sign of the battle raging around bitcoin, a FinCEN-led international illicit financing task force arrested a Russian “mastermind of organized crime” on a small beachside village in northern Greece less than two weeks ago.
Alexander Vinnik, who is accused of laundering more than $4 billion worth of illegal funds using bitcoin accounts, operated BTC-e, one of the world’s oldest bitcoin exchanges.
U.S. authorities accuse Mr. Vinnik of facilitating crimes including drug trafficking, public corruption, hacking, fraud, identity theft and tax refund fraud."
______________________________

The Guardian: "Stephen Barclay, the economic secretary to the Treasury, set out the government’s plans in a written parliamentary answer in October. “The UK government is currently negotiating amendments to the anti-money-laundering directive that will bring virtual currency exchange platforms and custodian wallet providers into anti-money laundering and counter-terrorist financing regulation, which will result in these firms’ activities being overseen by national competent authorities for these areas.

“The government supports the intention behind these amendments. We expect these negotiations to conclude at EU level in late 2017 or early 2018.”


_______________________________



Tuesday, 13 February 2018

Killing canaries

One of the first rules of HFT club was, "don't talk about canaries."

Yesterday Alexander Osipovich wrote an interesting article in the WSJ, "Glitch Exploited by High-Speed Traders is Back at CME."

This a follow up on the WSJ article from 2013, "High-Speed Traders Exploit Loophole" written by Scott Patterson,  Jenny Strasburg and  Liam Pleven.

This earlier article was a beat-up in 2013. I meandered about such canaries at CME somewhat poorly here, "Well known trading secrets become public."  I don't wish to repeat myself. That meander still stands as a relevant article. If you're short of time and wish to grok the issue: read it and ignore this meander.

No HFT market maker (MM) likes the idea of killing canaries. Once upon a time, perhaps only reading about killing kittens would be more controversial to see in the Wall Street press. Not that I understand that last sentence.

Inny or Outty?
(don't click to enlarge)
Mr Osipovich's current article is both hyperbole and understatement worth reading. This is different to the previous WSJ CME article which was largely just misplaced hyperbole similar to the benign misunderstanding of someone seeing their belly button for the first time. What hideous purpose could it have?!

I certainly feel it is wrong to call the availability of canaries a defect or bug. Most exchanges and even pre-electronic, pre-bronze-age markets have always worked that way. This is simply because the person closest hears first. Usually, the order placer recognises the acknowledgement first, even if just a hand signal. In the electronic world, it is a natural outcome of simple system architecture due to market data taking extra steps of processing and thus being more delayed.

CBOT Bond Pit circa 1995 - (click to enlarge)
I do think such a short delay is an improvement on the old US 30 year bond floor where various prices traded simultaneously where only a floor body knew best. Back in 1993/4, I loved listening to a big figure of price difference across the floor on the voice box in Sydney when the non-farm payrolls came out with unexpected fury in tow. My Reuter's feed was disappointingly orderly and a trap for systematic traders.

To reiterate, there is some sense to faster order feedback. It may be judged fair that a user gets to know about their own fill before the rest of the market so they may take hedging or related activity before being swamped by the rest of the market. It seems a not unreasonable right (despite the double negative) for the risk an MM takes in posting a price, no? However, this may also be used to gain a latency advantage with sacrificial canary orders getting killed by the marauding market. It's a balance.

Most markets have always worked this way. Nevertheless, there is a growing sense that it is better if such order information was public first. I don't think that is unreasonable, just as I don't think it is unreasonable the order placer gets notified first. You make choices as there is an argument both ways. I do like the idea of one-way order information with all private and public information in the one market data feed. Such an approach may have issues with IOCs and microbursts, but that becomes a design argument. There are many ways to skin the cat, kitten, or canary.

Where Mr Osipovich gets it right, or perhaps even understates it, is the magnitude of the delay measured with the help of Quantlab and others,
"Data from Quantlab’s trading in 10-year Treasury futures—a popular interest-rate contract—suggest that CME quickly fixed the latency problem in 2013, but for reasons that are unclear, it crept back into the exchange’s systems two years ago. By December, the median private-over-public advantage that Quantlab saw was around 100 microseconds. In about 10% of the firm’s trades, the delay was well over 2,000 microseconds.
Such latencies can vary widely. Still, people at several other high-speed trading firms confirmed they regularly saw similar delays in other CME markets, including futures tied to the S&P 500 and crude oil. One of the people said his firm often saw delays of more than 200 microseconds in oil futures."
A hundred microseconds is perhaps a bit long but it falls into an arguable range. Two thousand microseconds for about ten percent of orders is outrageous. Anyone should see that as inexcusable at such a modern exchange. That makes the article's hyperbole a little more palatable as such delays are newsworthy and a credit to Mr Osipovich's reporting.

Following the article, I heard cries of outrage in the Twitter-sphere. The Internet reacting over-the-top? Colour me surprised. Many people argued that some kind of Machiavellian deal had to have taken place between market makers and the CME. While you can't rule out such a possibility, it feels a little silly when applying Hanlon's razor makes it more certain such canaries are a bug rather than a feature.
In The Sorrows of Young Werther [1774] Goethe declared, "Misunderstandings and neglect occasion more mischief in the world than even malice and wickedness. At all events, the two latter are of less frequent occurrence."
CME should fix it. The latency advantage should not be so large. The elimination of canaries is a reasonable approach. Nasdaq eliminated them long ago. I was told TMX killed their canaries six or seven years ago. Kipp Rogers makes an excellent point that reporting on the canary aspect and disclosing system change effects would be useful. He posted this superb example from Eurex,

(click to enlarge)
No canaries at Eurex. Eurex has done a brilliant job in addressing the issue. Part of the Eurex approach has been to adopt Metamako's MetaApp to enable measurement and reporting.  Deutsche Börse should be given credit for listening to their community. They have delivered not only a precise solution but the very model of a modern major general architecture for the ongoing management of such details.



CME has half of an excellent architecture with their iLink FPGA gateways. When first introduced, they were a little all over the place with systematic gateway advantages due to different time syncs before they got the distributed time sync right. On the way in, CME iLinks timestamp the packets allowing fair system-wide ordering. It is a neat solution to otherwise needing to guarantee low-latency time priority ordering at a central point. Near enough really is good enough - sometimes.

CME could solve the canary issue in one of four ways off the top of my head, but there may be more if you are less impatient with your spare time and think for longer than thirty seconds:
  1. CME could reduce the canary difference to something acceptable and ensure they have production, development, and acceptance test monitoring in place. Layer one switches certainly make such tracking easier. See, "Using the matrix - exchange and enterprise network improvement." My team has used layer one switches, like Metamako's, to configure networks and for measuring latencies for every source code check-in so every nanosecond was always accounted for. That is, canaries don't necessarily need to be eliminated but canary flocks need to be controlled to prevent such anomalies.
  2. CME could eliminate order feedback channels and just use public feeds, including the embedding of private encrypted information where appropriate. Not an easy change.
  3. The groovy iLink architecture could be extended from the timestamp-on-the-way-in idea. Timestamps for publishing on the way out may be used to keep consistent deadlines for delivery at the gateway level. I wish the SEC would mandate such a mechanism for what I would call "Just Messaging" for news release delivery to all the major co-location points the financial community uses. Such geographic "Just Messaging" would be not-so-great for the well microwave endowed.
  4. CME could adopt similar principles to Eurex where canaries are designed out. This would be with appropriate monitoring and reporting, essentially extending 1) to the point where canary latencies are negative.
These should not be such big issues. My team in 2011 built an ATS matching platform using Mellanox Ethernet cards, Linux, Intel x86_64,  and straightforward C++ that could process a days Nasdaq data with 1.97 microseconds median wire to wire. This should highlight that delays of 2,000 microseconds are pretty inexcusable in 2018. We should do better. For what it is worth, here is my slightly dated meander on wire-to-wire latency targets for financial systems as at 2015, "Trade system performance - state of the art":
Ignoring other factors, which are almost always more important, my view on state of the art engineering, assuming a 10G connection, is roughly:
Hardware
Ho-hum   <  2,000 ns
Good       <  500 ns
Excellent <  100 ns
Software
Ho-hum <  10,000 ns
Good <  5,000 ns 
Excellent <  2,000 ns
This reduction remains reasonably relevant. CME's 2,000,000 nanoseconds of canary delay has no right to exist. Such canaries need to be killed.

Here is a secret for you. Guess the worst exchange for latency leakage - by design? It is an exchange that promotes themselves as the fairest of them all. Marketer, marketer, on the wall, who promotes the biggest bullshit of all? The InvestorSexChange (IEX), naturally. So much for investors. Your trades from the oxymoronically named IEX may appear at NYSE's and Nasdaq's co-lo well in advance of letting not only you know the fill, the customer who originated the order, but also in advance of all the IEX market data feed recipients too! Beat that disaster CME! This is thanks to IEX's SIP speed-bump bypass. You should spit-take your kool-aid if you're still drinking it. Yes, distributed flocks of canaries could be a thing if anyone bothered with such a lame little exchange that fleeces their customers with high fees whilst subverting NMS price discovery by trading more than 75% of the flow in the dark. I wonder if the press will ever pick up on the IEX hypocrisy rather than sniping at exchanges actually trying to do the right thing? Sorry, I couldn't resist. It annoys me so.

Another notable market microstructure outcome is that canaries often invalidate academic papers. Over the years I have often read papers that look at arbitrage, price transmission, geographical volatility dispersion, cointegration, et cetera, that are simply wrong due to their assumptions regarding market data. This is easy to see in some markets. If you look at some leader-follower correlated pairs in different geographies the cointegration seems to occur faster than the speed of light. That is, if you compare the market data timings from both places you may think c has suddenly become greater than 1.0 or there is some other mystical force at work. It's not magic. Sometimes, just sometimes, this is due to canaries. Sometimes it is an understandable misunderstanding of the extra overhead of one market delivery cycle from the order interface. Sometimes it is just latency bought by uncertain predictive methods. Unsurprisingly, published papers, even peer-reviewed ones, are occasionally wrong. Not an innate criticism. This is how it should be in a progressive world that encourages risk.

There are many HFT types out there who could wax lyrically about how many market-microstructure papers are wrong due to a lack of understanding that only practitioners truly understand. But, you know, magic tricks. Shhh.

Happy trading,

--Matt.




________________________

PS: Etymology. It has been nice to see the use of the word canary become a common financial cultural reference for such sacrificial latency-gaining orders. I first used the term back in 2005/6 when KRX canaries could provide you a whole second of an advantage as discussed here, "The accidental HFT firm." Many traders call it different things but I guess my freedom from confidentiality agreement as a consultant, aka unemployed (largely), enabled the popularisation of my coinage. It's not that original for something widely known, but I'll take it. I was talking to another trader last night who called them feelers. That's probably a more appropriate name in some regards even if not quite as colourful. Many people have different names for this long-time feature, but it is fun to see the term canary stick. There are some nice specialised canary species worthy of further discourse, but they'll remain in the HFT magic tricks book for some time - I hope.

PPS: An interesting way of thinking about a canary may be that it is just a technological rebate with all of the corresponding arguments for and against rebates. It is a bit of a limiting thought as such "rebates" are only available to those who value the latency edge and can execute both operationally and legally. That is, as Sam Tyfield points out with an entertaining rhyme below, a canary order with the sole purpose of seeking advantage may be unlawful in Europe as it is a ping equivalent even though the venue may be lit:

The rebuttable presumption risk is interesting. The legalities are getting a bit out of my depth, but it would seem that canary latency advantages reaped from the normal course of business would still be OK in Europe but you'd want to have a documented trading plan that supported your orders' intentions.




Monday, 12 February 2018

The weak week that was the week of vol that was

The minor threat of capital potentially have to compete with wages embedded in a noisy non-farm payroll report is the commonly blamed trigger for the outbreak of the 10% correction. Well, 10% so far.

Here is one view of the drama:

Blip source
Not too dramatic, hey?

Whilst forward-looking PEs are higher than average, but not overly onerous, they probably don't yet account for the likely wealth effects, changing confidence, and some of the whole holes of the Trump tax GAAP effects which may penalise a few firms in the short-term.

The VIX looks a little dramatic:


source
Everyone's favourite villain, the XIV wins the humour category, unless you were short vol by being long the widely misunderstood not-an-ETF:


The ironically named "LJM Preservation and Growth Fund", at one point had not preserved 82% of its capital. Professionals don't deserve a lot of sympathy for failing to understand leptokurtosis.

There certainly needs to be a review of retail access to some of these products. Cleverly disguised as ticker symbols you can buy and sell, some retail carnage followed. I'm a bit betwixted and between considering whether or not retail should have access to such products. On the libertarian side, why should Jane Doe be prevented from participating in a properly documented product? Who is to say Jane is not qualified to participate? On the safety first side, why should the complex nuances required to understand the structure of the possible returns be expected of retail? Especially in the case where such products hide behind a curtain of largely benign behaviour with the inevitable demons cleverly hidden within?

Perhaps there should be product levels - much like Dante's Inferno, or Donkey Kong. If you can explain kurtosis, the clustering of volatility, serial dependence, and vega, gamma, theta, rho, vanna, charm, vomma, veta, vera, speed, zomma, colour, and ultima you win a licence to unlock Level V which allows you to trade non-vanilla products; iff you can prove you have a verified risk management methodology. Expecting too much? Perhaps. On quite a few days in the last decade, I traded a million or two equity index options; and, yet, I had to look some of those terms up. My experience thus proves you don't have to be too smart to make money with vol related products. How should such products be restricted?

Fidelity thought it was OK for its customers to eventually get screwed by the products' by-product of an eventual limit price of zero - until the same customers finally got a chance to redeem some of their losses.

Horse bolts. Wait a few hours. Shut gate even though the horse is calm and wants to return to its stable. Give horse the bird. That is, Fidelity has cut off those products,
"Fidelity is trying to save investors from blowing up their accounts in another wacky fund.
This is probably the right thing for Fidelity though it may also be interpreted as an admission of guilt by a clever class action lawyer needing a new suit from a suit. The FT reports Fidelity do plan to open up the risk channels again but in a more controlled manner,
"The spokesperson for Fidelity said that they expect to allow retail investors to trade SVXY again in the “foreseeable future provided the market co-operates,” adding that only investors with the highest risk tolerance that specify that they understand how the product works are allowed to trade it."
Timing is everything.

Speaking of suits bearing suits, I hope Credit Suisse is losing some sleep over the potential outcomes of their XIV ETN. Matt Levine covers the situation fairly astutely in, "Inverse Volatility Products Almost Worked." I'm not quite so sanguine regarding Credit Suisse's ability to dodge a regulatory inquisition. There is a nasty bouquet around the lack of synchronicity between the products price and the VIX reality. Without APs there may be some responsibility that falls to CS, even if only to call a halt. It would have been terribly easy for CS or their contracted hedgers to profit from the product's plight, especially by trading ahead of product-related trades or by assigning the worst trades to the product. Perhaps there may be similarities drawn from this to the State Street ($382.4M) and BNY Mellon FX ($714M) scandals where appropriate prices were not provided to customers. Not sure that is the case, but it perhaps suggests such an inquiry should be. Where does the fiduciary responsibility lie amongst the lies?

Timing is everything.

Giving munitions to all citizens is dangerous even if the second amendment allows it. One self-appointed expert ended up in some quite disturbing distress,
"“I’ve lost $4 million, 3 years worth of work, and other people’s money,” he wrote in a post that’s garnering lots of attention.
You'd have to be pretty heartless not to have some sympathy but that has to be tempered with the reality he was dabbling with other people's money in something he did not comprehend. Mr Market is a harsh keeper of the score with little empathy for misunderstandings.

Whilst people in the US fight for their second amendment rights to conceal carry, we don't hear of any well-organised state militia stockpiling missiles, tanks, nuclear weapons, Mach 2+ fighters, nor stealth bombers. Really? What is the point in your handgun if you can't expect to be able to overthrow the government in a situation the founding fathers may have condoned? Similarly, products of mass wealth destruction need some controls. Preferably before it is too late next time.

All is not sad though. Whilst it is not a zero sum game due to connectedness and wealth effects, some winners emerged such as Artemis as reported by the Guardian,
"...a lot of people lost a lot of money. But Chris Cole, a 38-year-old hedge fund manager from Texas, wasn’t one of them. He made millions from his fund’s bet on a financial apocalypse" ...
"Cole said he has not worked out how much money he has personally made from his own money invested in Artemis, but joked: “If the market sells off the way I think it will, maybe I’ll buy a Bond-villain style base on a volcanic island in the Pacific.”"
We haven't heard what became of the infamous trader "50 Cent," supposedly Ruffer LLP, who spent scores of millions over the last twelve months buying calls at around 50 cents or less. The other notorious VIX option trader, the "VIX Elephant" would also have a story to tell. They may have been anxious that the VIX was going too high if the continuing trade was on their books as reported in the press.  Here is one Elephantine trade that was reported as extended to February in January according to Business Insider Australia,
Just six weeks after rolling over a massive wager that the CBOE Volatility Index, or VIX, would surge from its subdued levels by January, the volatility vigilante has essentially extended that bet into February. The so-called rollover carries the same maximum potential payout as before: an eye-popping $US262.5 million.
"Known to some as the “VIX Elephant,” the mystery investor has stubbornly clung to this trade since initiating it on July 21 of last year. That’s involved a pair of rollovers on September 25 and December 1, and now January 11."
  • To fund it, the investor sold 262,500 VIX puts expiring in February with a strike price of 12 
  • The trader then used those proceeds to buy a VIX 1×2 call spread, which involves buying 262,500 VIX February calls with a strike price of 15 and selling 525,000 VIX February calls with a strike price of 25. 
  • Bullish call spreads are used when a moderate rise in the underlying asset is expected. Traders buy call options at a specific strike price while selling the same number of calls of the same asset and expiration date at a higher strike.
Timing an exit with those calls at 25 would have been interesting.

It was speculated by Bloomberg "50 cent" may have become "30 cent" in January,
"“I think for a while ‘50 Cent’ became ‘30 Cent,’” said Pravit Chintawongvanich, head of derivatives strategy at Macro Risk Advisors. “There were a lot of prints that fit that bill, though you can never know if it’s the same person.”
50 Cent’s role as the most interesting -- and largest -- player in VIX options has largely been usurped by the so-called “VIX Elephant” who’s been putting on massive call spread trades since July."
Bloomberg reported on the supposed exit here of the "VIX Elephant", "Huge VIX Trader ‘Elephant’ Takes Profits on Volatility Rally,"
"The trades on Friday appeared to involve a new position via the sale of 262,500 $12 March puts, buying 262,500 $15 calls and selling 525,000 $25 calls. That was after closing out the prior existing position by buying back 262,500 February VIX puts with a strike price of $12, selling 262,500 $15 calls, and buying back 525,000 $25 calls."
Those calls were curiously interesting.

Also, Bloomberg reports, "This Tiny Hedge Fund Just Made 8,600% On a Vix Bet,"
'“Cooper and I go to New York a lot,” Rubin said. “In one instance, someone actually laughed in our faces at the type of options we were looking at.”'
"On Jan. 2, the managers put down $200,000 on what looked like a lottery ticket, with each SVXY put costing 34 cents. On Feb. 6, they sold the 6,300 contracts at about $28 each, leaving them with $17.5 million."
Further stories are sure to emerge in the coming daze.

Is there a bare chance of further downside, or will the correction bear the fruit of a bear?


That is the 6,400 billion dollar question, or so.

The NFP trigger into the spike was slight. There is not a lot of fundamental reason to be less sanguine about economic prospects given tame inflation, low unemployment, and a decent growth outlook. There is a lot worry about in the decade-long over liquified pumped up economy bubbling asset prices higher, but is this really enough of a trigger?

We've seen trend followers take a beating, (FT),
"A Société Générale index indicated that trend-following funds lost 5 per cent from last Thursday to Tuesday. Man AHL’s quantitative trend-following funds were down between 2.2 per cent and 4.7 per cent just on Monday, while a trend-following fund run by Lynx Asset Management has fallen more than 11 per cent this month."
The more significant warning comes at the end of the FT article,
"One trend-following fund executive admitted its stock market exposure had been sliced by almost a third over the past week, while analysts at Bank of America and JPMorgan estimate that the turbulence would have been enough to trigger roughly $200bn of equity selling. However, the CTA industry argues that their de-risking is far too modest and gradual to rock global markets." 
It is the potential simultaneous deleverage that is the most dangerous. It may be that it is already over, but it is too soon to tell. This aspect of correlated, simultaneous deleveraging has been well covered in past literature related to crises. For example, see the "The Unwind Hypothesis" section (pp26-) in Amir Khandani and Andrew Lo's 2007 paper, "What Happened To The Quants In August 2007?",
"The large losses on Tuesday and Wednesday—amounting to −15.98% for our leveraged-contrarian strategy—would almost surely have spilled over to long/short equity funds as well as to certain quantitative long-only funds. In particular, if our hypothesis is correct that the losses on August 7th and 8th were caused by the unwinding of large equity market-neutral portfolios, then any explicit factors used to construct that portfolio would have generated a loss for other portfolios with the same factor exposures. For example, if the portfolios that were unwound happened to be long low-P/E stocks and short low-dividend-yield stocks, the impact of the unwind will cause low-P/E stocks to decline and low-dividend-yield stocks to rise (albeit temporarily, until the unwind is complete). All other portfolios with these same factor exposures will suffer losses during the unwind process as well. 
How likely is it that other funds would have the same factor exposures? If they use similar quantitative portfolio construction techniques, then more often than not, they will make the same kind of bets because these techniques are based on the same historical data, which will point to the same empirical anomalies to be exploited, e.g., the value premium, the size premium, the January effect, six-month momentum, one-month mean reversion, earnings surprise, etc. Moreover, the widespread use of standardized factor risk models such as those from MSCI/BARRA or Northfield Information Systems by many quantitative managers will almost certainly create common exposures among those managers to the risk factors contained in such platforms.
But even more significant is the fact that many of these empirical regularities have been incorporated into non-quantitative equity investment processes, including fundamental “bottom-up” valuation approaches like value/growth characteristics, earnings quality, and financial ratio analysis. Therefore, a sudden liquidation of a quantitative equity market-neutral portfolio could have far broader repercussions, depending on that portfolio’s specific factor exposures."
Fundamentally, people like similar things and dislike similar things. If increased vol makes you unwind a little then suddenly lots of people are buying things they disliked and selling things they like to deleverage causing bad things to rally and the good to sell off. Many funds are adjusting to high vol by deleveraging. Margin requirements are up, causing deleveraging. People are retiring to the sidelines, causing a deleveraging. Risk limits are being reevaluated with some urgency. Others smell opportunity in the morning's napalm. Crazy opportunities abound.

It will be interesting, perhaps in the Chinese curse way, to see how the market handles this spike in increased vol in this seemingly accelerated market.

Market valuations remain high. The equity market infrastructure in the US held up surprisingly well. Though the market was thinned from time to time, bids and offers largely remained with HFT market makers both providing prices and reaping the benefit of higher vol.

The correction we had to have


Perma-bear Jim Rogers has predicted the last 20 bear markets out of the two that have occurred. Blind Fredricka knew this kind of correction was close due to the weird up-streak in equity prices during 2017 getting weirder in late 2017 and January 2018. I certainly noted it in December and I almost never stick my hand up about value. I'm no genius, plenty of people felt the same. However, in memory of Barton Biggs, sometimes you've gotta be a fully invested bear. Sometimes it is better to be fully invested and wrong even if waiting by the fire exit is dangerous in a stampede.

Timing is everything, but participation is often better.

Sometimes the always-going-up-in-the-long-term lore for equity markets is a really long term. Remember the 1929 peak was not exceeded until 1954. In 1968 we saw the S&P500 with a 102 handle as we did again in August 1982. In March 2000 the S&P500 closed one day at 1527 and on 26th February 2013 it closed at less than 1500. Buy and hold works unless you die waiting.

Timing is timing.

It is interesting to consider the so-called bond crash of '94. It was triggered by a much more significant NFP result. At the time, the market had been trained over the preceding years to buy on the dip. My neural network models at the time certainly thought that too. The whole Street bought on the dip. Long and wrong. If you go back and look at the US 30yr bond history you won't see much that stands out, unless you go and read the old WSJ headlines screaming disaster. My ye olde trend models ended turning and selling the retreat nicely, so perhaps today's lower-tech quant funds will be OK if the bear emerges. There is a risk that nags though. The newer AI strats may be like my ancient neural networks of '94. They may be unprepared for this event as they buy the dip. Then again, they may be the buyers that save the day through their overly clever foolishness. Food for thought.

Equity valuations continue to be excessive (see Shiller PE ratio chart at the top of the page), but no new compelling economic catalyst hints at a bear (yet). It remains to be seen if the current technical / market factors are enough to drive the market into the cave of the bear.

At least the PEG, thanks to optimistic EPS expectations, remains favourable:

Bloomberg, "When Will It End? Bloodied Traders Seeking Clues"
Goodluck with your timing and happy trading,

--Matt.