The Flash Crash:Impact of High Frequency Trading and Regulatory Implications

Andrei KirilenkoCommodity Futures Trading Commission

based on joint work with

Pete Kyle (UMD), Mehrdad Samadi (UNC) and Tugkan Tuzun (FRB)

This presentation and the views presented here represent only our views and do not necessarily represent the views of the Commission, Commissioners or staff of the

Commodity Futures Trading Commission.

The Flash Crash - May 6, 2010

8:30 8:48 9:08 9:27 9:46 10:05 10:24 10:43 11:02 11:21 11:40 11:59 12:18 12:37 12:56 13:15 13:34 13:53 14:11 14:31 14:50 9,800

10,000

10,200

10,400

10,600

10,800

11,000

1,020

1,040

1,060

1,080

1,100

1,120

1,140

1,160

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DJIA

E-Mini S&P 500

S&P 500 Index

Time

DJI

A

S&P

500

What did people think?

A survey conducted by Market Strategies International in June 2010 reports that over 80 percent of U.S. retail advisors believe that

“overreliance on computer systems and high-frequency trading”

were the primary contributors to the volatility observed on May 6.

This paper:

Use audit-trail data for the E-mini S&P 500 stock index futures contract to answer three questions:

How did High Frequency Traders and others traded on May 6?

What may have triggered the Flash Crash?

What role did High Frequency Traders play in the Flash Crash?

Findings:

High Frequency Traders did not cause the Flash Crash.

On May 6, HFTs traded the same way as they did on May 3-5: Small inventory, high trading volume, take more liquidity than provide.

A large, but short lived imbalance between Fundamental Sellers and Fundamental Buyers appeared.

Opportunistic Traders held it, but for a massive price concession.

Fundamental Buyers eventually stepped in and pushed prices up.

Literature:Algorithmic Trading:

Chaboud, Chiquoine, Hjalmarsson, and Vega (2009)Hendershott, Jones and Menkveld (2010)Hendershott and Riordan (2011)

High Frequency Trading: Brogaard (2010)Menkveld (2011)

Low Latency Trading: Hasbrouck and Saar (2011)

Flash Crash: Easley, O'Hara, and Prado (2010)Madhavan (2011)

E-mini S&P 500 futures contract

Trades exclusively on the CME Globex electronic trading platform.

Highest dollar trading volume among U.S. equity index products.

Contributes the most to price discovery of the S&P 500 index: Hasbrouck (2003).

Price discovery typically occurs in the front-month contract.

CFTC audit trail transaction-level data for the June 2010 contract: Date, Time, Globex Match ID, Price, Quantity, Trader Account, Trade Direction, Order Type, Order ID, Aggressiveness Flag.

June 2010 E-mini S&P 500: Trading Volume and Price

8:30 8:48 9:06 9:24 9:42 10:00 10:18 10:36 10:54 11:12 11:30 11:48 12:06 12:24 12:42 13:00 13:18 13:36 13:54 14:12 14:30 14:48 15:060

10000

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Volume

Price

Time

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ume

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e

Trader Categories• High Frequency Traders (16): Data for May 3-5, low net holdings, highest volume traders.• Intermediaries (179): Data for May 3-5, low net holdings, significant volume traders.• Fundamental Buyers (1263) and Sellers (1276): Data for May 6, directional net long or short, low volume traders• Small Traders (Noise) (6880): 9 or fewer contracts traded on May 6 (about 500,000 dollars)• Opportunistic Traders (5808): Everyone else – cross-market, stat. arb., etc.

Trader Categories

0 2000 4000 6000 8000 10000 12000 14000 16000 18000 200000.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

Rank

% o

f Vol

ume

HFT

Opp

Fundamental

Noise

Int

0 2000 4000 6000 8000 10000 12000 14000 16000 18000 200000.00%

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

Rank

% o

f Tra

des

HFT

Opp

Fundamental

Noise

Int

Trader Categories

-0.00736000000000001 0.002639999999999990

100000

200000

300000

400000

500000

600000

700000 May 3

Tra

der

Vol

ume

High Frequency Traders

Opportunistic Traders and Intermediaries

Fundamental Sellers Fundamental Buyers

0

100000

200000

300000

400000

500000

600000

700000May 4

Tra

der

Volu

me

High Frequency Traders

Opportunistic Traders and Intermediaries

Fundamental Sellers Fundamental Buyers

-0.00736000000000001 -0.00236000000000001 0.002639999999999990

100000

200000

300000

400000

500000

600000

700000May 5

Tra

der

Vol

ume

High Frequency Traders

Opportunistic Traders and Intermediaries

Fundamental Sellers Fundamental Buyers

-0.00736000000000001 0.002639999999999990

100000

200000

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700000 May 6

Net Position Scaled by Market Trading Volume

Tra

der

Vol

ume

High Frequency Traders

Opportunistic Traders and Intermediaries

Fundamental Sellers Fundamental Buyers

Trader Category Summary Statistics

16 HFT accounts are responsible for almost a third of trading volume…

Net Holdings of High Frequency Traders

8:31 9:06 9:41 10:1610:5111:2612:0112:3613:1113:4614:2114:56-3000

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0

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May 3

HFT NPPrice

Time

Net P

ositi

on

8:31 9:06 9:41 10:1610:5111:2612:0112:3613:1113:4614:2114:56-4000

-3000

-2000

-1000

0

1000

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1155

1160

1165

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1175

1180

1185

May 4

8:31 9:05 9:39 10:1310:4711:2111:5512:2913:0313:3714:1114:45-5000

-4000

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0

1000

2000

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1145

1150

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1160

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1175May 5

mtime 9:05 9:40 10:1510:5011:2512:0012:3513:1013:4514:2014:55-5000

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0

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May 6

Yet they do not accumulate of position larger than 4500 contracts!

Aggressiveness Imbalance: HFTs

8:31 8:51 9:11 9:30 9:51 10:1110:3110:5111:11 11:3111:5112:11 12:3012:5113:11 13:3113:5114:11 14:3114:5015:10-4000

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HFT Buy Imbalance HFT Sell Imbalance Price

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Net Holdings of Intermediaries

8:31 9:04 9:37 10:1010:4311:1611:4912:2112:5513:2814:0114:3415:07-2000

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May 3

INT NPPrice

Time

Net P

ositi

on

8:31 9:07 9:43 10:1910:5511:3112:0712:4313:1913:5514:3115:07-2000

-1500

-1000

-500

0

500

1000

1500

1155

1160

1165

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1175

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1185

May 4

8:31 9:04 9:37 10:1010:4311:1611:4912:2112:5513:2814:0114:3415:07-1500

-1000

-500

0

500

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1145

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May 5

mtime 9:05 9:40 10:1510:5011:2512:0012:3513:1013:4514:2014:55-1500

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May 6

Aggressiveness Imbalance: Intermediaries

8:31 8:50 9:08 9:28 9:47 10:0610:2510:4411:0311:2211:4112:0012:1912:3812:5613:1513:3513:5414:1314:3114:5015:10-1500

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INT Buy Imbalance INT Sell Imbalance Price

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e

HFTs: Net Holdings and Prices

May 3-5

HFTs reduce 0.6 percent of their net holdings in 1 second.

HFTs trade in the direction of the price movement for the first 5 seconds.

Trade in the direction opposite the price movement after 10 seconds.

Interpretation: Speed or predictive ability enables HFTs to buy right when prices are about to increase and sell after the prices rose.

HFTs: Net Holdings and Prices

May 6

HFTs trade in the direction of the price movement for the first 2 seconds.

Trade in the direction opposite the price movement after 4 seconds.

On May 6, HFTs reverse the direction of their trading a lot faster

Follow the same strategy, but do it faster

Intermediaries: Net Holdings and Prices

May 3-5

Intermediaries reduce 0.4 percent of their net holdings in 1 second.

Intermediaries trade opposite the price movement for the first 2 seconds.

Trade in the same direction as price after 3 seconds.

May 6

Intermediaries trade opposite the price movement contemporaneously.

Reverse the direction of trade at lags 1 through 4.

Intermediaries get run over by the price move.

HFTs: Liquidity Provision (Passive) or Removal (Aggressive)

May 3-5

Aggressively reduce 0.5 percent of their net holdings in 1 second.

Aggressively trade in the direction of the price movement for the first 6 seconds.

Aggressively trade in the direction opposite the price movement after 10 seconds.

Passively provide liquidity at all lags, but with smaller coefficients

May 6

Same strategy, but faster

HFTs more aggressively remove liquidity, then passively supply it

Intermediaries: Liquidity Provision (Passive) or Removal (Aggressive)

May 3-5

Aggressively reduce 0.2 percent of their net holdings in 1 second.

Aggressively trade in the direction of the price movement for the first 12 seconds.

Passively provide liquidity at all lags, and with larger coefficients

May 6

Smaller coefficients

Intermediaries provide liquidity; did less of it on May 6

Profits and Losses of High Frequency Traders

Never negative.

8:31 9:21 10:1111:0011:5112:4113:3114:2115:10$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

1155

1160

1165

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May 4

8:31 9:20 10:0910:5811:4712:3613:2414:1415:03$0

$1,000,000

$2,000,000

$3,000,000

$4,000,000

$5,000,000

$6,000,000

1020

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8:31 9:23 10:1511:0711:5912:5113:4214:35$0

$100,000

$200,000

$300,000

$400,000

$500,000

$600,000

$700,000

$800,000

1180

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May 3HFT...

8:31 9:18 10:0510:5211:3912:2613:1314:0014:47-$200,000

$0

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$400,000

$600,000

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$1,000,000

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1145

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May 5

Profits and Losses of Intermediaries

8:31 9:20 10:0910:5811:4712:3613:2414:1415:03-$100,000

$0

$100,000

$200,000

$300,000

$400,000

$500,000

1155

1160

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1185May 4

8:31 9:19 10:0710:5511:4312:3013:1914:0714:54-$100,000

-$50,000

$0

$50,000

$100,000

$150,000

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1145

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8:31 9:20 10:0910:5811:4712:3613:2414:1415:03-$3,500,000

-$3,000,000

-$2,500,000

-$2,000,000

-$1,500,000

-$1,000,000

-$500,000

$0

$500,000

$1,000,000

1020

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1080

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1180May 6

8:31 9:19 10:0710:5511:4312:3013:1914:0714:54-$50,000

$0

$50,000

$100,000

$150,000

$200,000

$250,000

1180

1185

1190

1195

1200

1205May 3

INT...

HFTs and Intermediaries: The Flash Crash

DOWN (13:32:00-13:45:28 CT)

HFTs follow the same strategy

Intermediaries get caught on the wrong side

UP (13:45:33-14:08:00 CT)

HFTs are less aggressive (fundamental and opportunistic buyers are)

Intermediaries close positions and about half of them withdraw

Fundamental Traders

Fundamental Traders: Flash Crash

Opportunistic Traders: Making the Flash Crash Systemic

-25000

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Opportunistic Fundamental Sellers Fundamental Buyers Price

Time

Net

Pos

ition

Cha

nge

Pri

ce

Cumulative Aggressiveness Imbalance

8:30 8:48 9:06 9:24 9:42 10:0010:1810:3610:5411:1211:3011:4812:0612:2412:4213:0013:1813:3613:5414:1214:3014:4815:06-150000

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Aggressiveness Imbalance

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The Flash Crash

13:32 A large fundamental seller initiates a sell program

13:42 HFTs reverse the direction of their trading (start selling)

13:45 “Hot Potato”: Lack of Fundamental and Opportunistic Buyers

13:45:28 - 13:45:33 5 second trading pause

13: 45:33 – 13:45:58 Prices stabilize

13:46 Fundamental Buyers lift prices up

14:08 Prices are at the 13:32 level

The Flash Crash: CFTC-SEC Report

Large Fundamental Seller – hedges exposure in equities

Sell Algorithm – sell 75,000 E-mini’s with 9% volume participation target

Size – Largest net position of the year executed in about 20 minutes

Price Decline – sells 35,000 ($1.9 billion) contracts in 13 minutes

Cross-Market Arbitrage – buy E-mini/sell SPY or basket of equities

Across the Board Price Declines – trigger automated pauses

Lack of Liquidity in Individual Equities – systems reset to reflect higher risk

Broken Trades – retail stop loss orders executed against stub quotes

Conclusions

A large trade will always have an impact and may trigger a cascade

Volume is really not the same as liquidity

HFTs did not cause the Flash Crash, HFTS are not liquidity providers

Questions

Fundamental Buyers – why did it take so long?

How did the 5-second pause work?

More safeguards needed to prevent cascades. How dumb/smart?

The CFTC-SEC Joint Advisory Committee on Emerging Regulatory Issues

Recommendations Regarding Regulatory Responses to the Market Events of May 6, 2011 Summary Report presented at the public meeting on February 18, 2011

I. Dealing with volatility in individual instruments: single stock pauses/circuit breakers;minimum quoting requirements for securities; limit up/limit down for securities;enhancements to pre-trade risk safeguards/pauses for the futures.

II. Dealing with market-wide volatility: market-wide circuit breakers:use S&P 500;start at 10 percent;pause for as low as 10 minutes;go as late as 3:30 p.m.

The CFTC-SEC Joint Advisory Committee (continued)

III. Restrictions on co-location/access/disruptive trading practices:support the SEC’s “naked access” rulemaking;support the CFTC’s disruptive trading rulemaking;look into restrictions on the executions of large orders.

IV. Liquidity Enhancements:“peak load” pricing;“reasonably related” market making quotes ;“trade at” rule for routers/internalizers;order cancellation fees;reporting new measures of liquidity.

V. Regulators’ Access to Information: consolidated audit trail for the SEC;order book and ownership data for the CFTC.

May 3

Tra

der

Vol

ume

High Frequency Traders

Opportunistic Traders and Intermediaries

Fundamental Sellers Fundamental Buyers

Net Position Scaled by Market Trading Volume

May 4

Tra

der

Vol

ume High Frequency Traders

Opportunistic Traders and Intermediaries

Fundamental Sellers Fundamental Buyers

Net Position Scaled by Market Trading Volume

May 5

Tra

der

Vol

ume

High Frequency Traders

Opportunistic Traders and Intermediaries

Fundamental Sellers Fundamental Buyers

Net Position Scaled by Market Trading Volume

May 6

Net Position Scaled by Market Trading Volume

Tra

der

Vol

ume

High Frequency Traders

Opportunistic Traders and Intermediaries

Fundamental Sellers Fundamental Buyers