Yesterday, the CFTC approved the first “trading speed bump” for US silver and gold futures markets. Normally this might only get a mention as a feature article by your friendly Gold Enthusiast, but as you will see there are some points that bear attention, and possibly even – perish the thought – deeper thinking.
You see, there’s a big difference between doing something to “do something”, and actually doing something that helps fix the actual problem. Sadly, the speed bump approved by the CFTC does not seem to actually fix a real problem, but rather just imposes a delay in the markets. Which is not what markets need. The things markets need to be policed are #1 transparency and #2 legitimacy.
What the CFTC has approved is a 3-millisecond delay in orders sent into the exchange that match existing offers already on the exchange. Let’s say there’s an offer already on the market (an ask) to sell 100 oz of silver on the exchange at 14.85, and there is no matching bid yet. If Speed Trader Boy #14 sends in an order to “hit” that order, it would be delayed by 3 milliseconds before it would be listed. Then if the ask was still available they would be matched and executed.
“Come on Gold Enthusiast, how can 3-milliseconds make a difference?” We can hear you asking. Well, in normal mid-day market trading, it doesn’t. In a fast-moving market (think the first 2 minutes of a big trading day), it could mean quite a bit. We don’t have recent info on actual speed of order matching on the ICE, but the old data we recall implied 1.5 milliseconds was where significance started. (sorry, can’t find the reference at the moment – feels like Monday around here…) If our memory is correct, this would explain where this 3-millisecond rule comes from, as that would be twice-significance, which any statistician would tell you is quite significant.
So in that sense it makes sense. But what doesn’t make sense is what issue are they trying to fix? The real problem with so-called flash trading is that a few huge-size orders can halt or reverse the direction of a market move. And, if you recall the problems with flash trading during the dot-com crash, several of the significant market moves were traced to orders that were entered on the exchange then canceled before they were executed, perhaps only existing on the exchange for a few milliseconds at most. Such orders skew the appearance of supply vs demand, which greatly distorts the picture of market conditions.
Think of it this way. You want a shiny new Corvette because you think it’s the fastest coolest thing since your childhood Hot Wheel cars. And you know they’re made by Chevy so there must be a zillion of them available. So you trot down to your corner Chevy store where they have 5 of them gleaming on the front row. “Sorry,” says Perky The Salesboy, “we have orders for all these. If you want one you have to pay 5 thousand more than list price.”
In a free market economy that’s fine, high demand is expected to drive up prices. But what if Perky is BS’ing you? BS’ing is a highly technical term meaning he’s lying, all those cars aren’t really sold, Perky is just scamming you to get you to pay more.
And that’s the real concern with high-frequency trading. It’s not the real orders representing real demand that are the problem, it’s the orders that will suddenly disappear if the price moves in their direction.
Here are your Gold Enthusiast’s suggestions for addressing the 2 things that really need policing (#1 transparency, #2 legitimacy). For transparency, the identity of all market participants must be made known. Maybe not their specific name (Joe Brown at 14 East Street), but at least their investor category: Central bank, International Bank, National Bank, Huge Investor, Average Investor, Small Investor — whatever makes the most sense. Market participants need to know when and how “the big boys” are acting in the market, and which kind of big boys they are. You can almost clump all us little guys – aka “retail” investors – in one group, as we don’t seem to wreck any markets with our 100 or 1000 share transactions.
Exposing central bank moves and huge influential investor moves is critical as it tells Bill Average which country is doing what in which market. We need to know if Sealand (for example, not picking on anyone in particular) is trying to corner the world market in palladium. Or if the US Fed has suddenly gone on a gold buying spree. (We’d LOVE to see that – haha!!!)
For legitimacy – and this is the really big one – We need to know that every order on the market is a real order. During the dot-com crash, and less so during the 2008 drop, there were documented cases that flash traders were placing orders sized much larger than their account values could justify. To really move any decent-sized market with real orders takes REALLY big money, the kind that only a few individual investors have. So we would recommend strict enforcement of capital and margin requirements as step #1.
Step #2 is more severe. Require all orders to remain open on the market for at least 10 seconds. Yes, that’s 10 full seconds. Combined with strictly enforcing capital and margin requirements, this would end any practice of putting in dummy orders to move the market one way or the other. The risk of an order being hit and committing capital – and broker reputations – should put an end to any dummy ordering.
It’s a dream, we know, but it’s something to think about. What are your ideas for fixing market problems? We’d love to hear them – fire away in the Comments below.
The Gold Enthusiast
Disclaimer: No specific securities were mentioned in this article. The Gold Enthusiast would love to see fully-transparent markets where account size limited what traders (and countries!) could do. But then, your friendly Gold Enthusiast is at heart a romantic dreamer.