Legislating 'Common Sense' for Brokers
Flash Crash: should brokers be required to adopt "common sense" rules on dumping large orders into a fragile market?
I just got a note from an analyst, who said he was at a conference in Washington where CFTC chief Gary Gensler was speaking. Gensler spent half his speech to an OTC derivatives group talking about the flash crash sequence of events, focusing on how dealers should maybe have to have responsibilities not to submit market-destabilizing orders.
Gensler specifically said that the CFTC-SEC Joint Advisory Committee was considering "Requiring executing brokers to have an obligation to enter and exit in an orderly manner."
What prompted such a remark?
The trading community was surprised that the primary factor blamed for the Flash Crash — a 75,000 sale of e-Mini futures contracts worth $4.1 billion at 2:32pm ET — was done using an algorithm that relied solely on volume, not price or time.
In other words, this algorithm — which was put in by a human trader at an asset management firm (reportedly Waddell and Reed) and executed by a broker working for them — was executed specifically to dump as much product as possible on the market in the shortest amount of time, without regard to price or time.
Some traders have been openly skeptical about whether such a sale could have caused the drop that was seen (the report makes it clear that the sale precipitated a flood of other sell orders); still, most traders I have talked to feel felt that the use of this type of algorithm was ill-advised, given the circumstances.
They could have executed this order manually — where they would have seen the effect the order was having — but chose not to. We don't know why.
But Gensler is clearly concerned about this: "Should executing brokers have to adopt certain trading practices when executing a large order by use of an algorithm, such as price or volume limits?"
You think he's worried...you should see what some high-frequency traders (HFT) are saying. HFTs certainly come in for some share of the blame in the report, but most seem relieved that the precipitating factor was blamed on an algorithm entered by an asset management firm, not an HFT.
Dave Cummings, founder of BATS and currently running HFT firm TradeBot, put out a comment that led with the line: "Wow! Who puts in a $4.1 billion order without a limit price? The trader at Waddell & Reed showed historic incompetence."
His conclusion: "This was a human mistake."
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