John Bates
08-04-2010 08:09 AM At the CFTC's first Technology Advisory Council meeting on July 14,there was concern expressed around the concept of quote-stuffing. There wassome evidence presented that the May 6th flash crash may have been caused by orexacerbated by this activity. While with regard to the flashcrash, other marketexperts I've spoken to know dispute this was the cause, quote-stuffing is atopic worthy of discussion
At the CFTC meeting, where I was an invited participant, data waspresented from trade database development firm Nanex, which suggested quotestuffing contributed to the destabilization on May 6th. In this casethe data suggests huge numbers of quotes were fired into the market onparticular symbols (as many as 5000 per second) and that many of these wereoutside the national best bid/offer (NBBO). So what's the point of this? Wellwith latency as a key weapon, one possibility is that the generating traderscan ignore these quotes while the rest of the market has to process and respondto them - giving an advantage to the initiator. Even more cynically one canconsider these quotes misleading or even destabilizing the market. In fact,Nanex state in their paper: "What we discovered was a manipulative devicewith destabilizing effect". Quote stuffing may be innocent or an honestmistake, but Nanex's graphs tell a very interesting tale (http://www.nanex.net/FlashCrash/CCircleDay.html).There are patterns detected - on a regular basis - that one could conclude isquote stuffing for the purpose of market manipulation.
At the extreme, quote-stuffing could operate like a “denial ofservice attack” - firing so many orders that the market can't cope - andcrippling the trading of certain symbols, certain exchanges or the wholemarket. An influx of orders in sudden bursts to one exchange on one stock canslow down that system as it tries to process these orders. Nanex notes thatthere are 4,000 stocks listed on the NYSE and nine other reporting exchanges inthe U.S. If each reporting exchange for each stock quoted at 5,000 quotes persecond it would equal 180.0 million quotes per second. A daunting task nomatter how advanced their processing technology is.
Without trying to overstate the issue, in the most extremecircumstances these practices could be considered algorithmic terrorism. Onecan imagine how, at the extreme, it is potentially catastrophic. The concern isthat a well-funded terrorist organization might use such tactics in the futureto manipulate or cripple the market. So much of our economy is underpinned byelectronic trading - so protecting the market is more important than guardingFort Knox! Regulators, such as the CFTC and SEC are taking this seriously - andneed to respond.
