CME Group went on the defensive last Wednesday after The Wall Street Journal (WSJ) in a front-page expose said high-speed traders using powerful computers are trying to profit from being able to see their futures market orders executed milliseconds before the rest of the market is able to see them.
Commodity Futures Trading Commission (CFTC) Commissioner Bart Chilton in a speech last week said there is research that shows high frequency traders (HFT), or “cheetahs,” impose “quantifiable costs on small investors.”
With the steady migration from open pit to electronic trading beginning more than a decade ago, a majority of the futures market volume now comes from trades made electronically. And while high-speed trading has been a known strategy in trader circles for years, the WSJ article put a broad spotlight on the practice and on whether having information a fraction of a second before the rest of the market constitutes an unfair advantage.
Responding to the outcry over the report, CME Group, which operates the Chicago Mercantile Exchange and the New York Mercantile Exchange, among others, allowed that while there may be times — out of the more than 300 million messages that come into its platform each day — when customers can “experience a latency of a few milliseconds” between the time they receive their trade confirmations and when that information is accessible on the public feed, these instances “are not consistent” and “vary across asset classes.”
The exchange operator added that it is continually making improvements to the trading platform to increase efficiencies, including variability between the time a firm or customer receives its trade confirmation and it appears on the public data feed.
While speaking in front of the Energy Bar Association in Washington, DC, last Wednesday, Chilton commented on cheetahs and their impact on the commodity markets.
“These HFTs are so fast, like the cats, that they are out there 24-7-365 trying to scoop up micro dollars in milliseconds,” he told the audience. “And they are winning.” Highlighting the fact that these speedy traders exploit a loophole that allows their powerful computers to detect when their orders are executed a split second before other market participants see the data, Chilton queried, “Can you imagine the advantage that may give the cheetahs?” The cheetahs buy, then, “as fast as they can, like a hot potato that carries risk with it,” they sell.
Citing a study done last year in conjunction with the CFTC, Chilton said cheetah trading imposes quantifiable costs on small investors. “Aggressive cheetahs make a lot of money, and they make their biggest paydays when they trade with small, traditional traders. A cheetah trading with a fundamental trader makes $1.92 on a $50,000 trade, but if that same trade is made with a small trader, the number goes up to $3.49. This could end up pushing smaller, non-cheetah traders out of markets. From most perspectives I can think of, that sort of fast isn’t better.”
Chilton noted that regulators are having trouble keeping up, noting that the Dodd-Frank Wall Street Reform Act legislation makes no mention of high-speed traders. “Landmark legislation from not three years ago doesn’t contain a word about traders who many times make up a majority of the volume of exchange trading,” he said.
While the WSJ story mentioned by name crude oil, silver, gold, soybean and corn futures, there have been rumblings among traders and analysts within the natural gas futures community as well.
Tim Evans, a veteran analyst with Citi Futures Perspective in New York, wasn’t sure how much of an advantage high-speed traders were receiving. “I don’t really think that there is much of an element of a surprise left with regard to high-speed trading,” he told NGI. “It is really impossible to quantify in terms of precise impact.
“The natural gas market has a long history of being volatile and being somewhat erratic and unpredictable. We’ve often seen natgas markets that move up when we think they should be going down, and vice versa. That’s just part of the spunky volatile character of the natural gas market. That was true in 1995 and I think it is still true today.”
Due to the volatility inherent in natural gas futures, high-speed trading in gas commodities might not be that big of an advantage, said Evans. “In the natural gas futures arena, it has been said that you could have the next three natural gas inventory reports already in your pocket and still not be able to make money trading natural gas. Knowing the number in advance sometimes could be a recipe for losing a lot of money. With high-speed trading there is at least a perceived fairness issue, because everyone should get the same information at the same instant. But realistically, are we all going to get the electrons on our screens simultaneously? No, we can’t expect that to be guaranteed.”
A Washington, DC-based commodities broker told NGI that it can be debated whether having the information milliseconds ahead of everyone else is advantageous, or how big of an advantage it might be, but the real argument should be about disclosure.
“The bigger issue in the post-MF Global, post-Amaranth, post-AIG and post-Enron world is, are you getting what you think you are getting as far as transparency? If you make the decision to trade on an exchange on a cleared basis, what are the rules of the road by which we trade? There are ups and downs with all of these things, the key is do you know what deal you are accepting, whether it be exchange traded and clear, dark pools, or any of these things? The high-speed trading issue had been known in the market prior to Wednesday, but the question is how many people were aware of it and did people understand the terms and conditions under which they were trading?”
The broker noted that talks of fairness and advantages have always been a difficult subject to define in markets. “Smart people should always be allowed to do their best, and we need people with countering views to make the market work,” the broker said.
“Sometimes people have an advantage because they have a larger pool of money, which is the way of the world. However, if I’m being told one thing, and in fact it is something else…that’s an issue. There is an issue of latency, the question is whether there is anyone using it for a consistent advantage? If the CME says it is fixing the system, but it will be this way until it gets fixed, then the people trading on the platform should know this. It comes down to transparency.”
CME said its goal is to bring variability “as close to zero as possible” and it said it has made significant steps to address latencies related to trade confirmations. “At the end of last year, we strengthened the overall performance of our CME Globex trading platform by reducing order response times and limiting variability within and across asset classes.
“In the first quarter of 2013 we upgraded our match-engine hardware. Through the remainder of this year, we will be implementing additional hardware, software and architectural upgrades — all designed to further reduce potential discrepancies in processing times, make the overall system performance more predictable, and enhance the CME Globex trading experience for our customers.”
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