Almost everyone we spoke to dismisses the idea of zombie algos that can run amok, at least in liquid futures contracts, but exchanges now require certification of algorithms before they can be deployed through co-location facilities. This means letting the exchange throw every weird market condition that they can think of at an algo and rejecting it if it behaves strangely. What’s more, if the exchange changes its code, the algos often have to go through the process again. That, however, hasn’t prevented a few funny things from happening.
In “Crude loop” (below), we see an aberration that began at 1:59:57 p.m. on Feb. 13, 2012, when quotes and trades on Nymex crude futures began queuing, only to be unleashed all at once at 2:00:35. Less than a minute later, at 2:01:08, it happened again — this time with quotes from the first 38 seconds and the intervening period. This repeated 12 times, each time with accurate timestamps that should have alerted algorithms to the fact that the quotes were old. But the algos reacted as if the quotes were real.
“Every blip led to an explosion of activity in USO, UCO and SCO — ETFs that mimic the price of oil,” Hunsader says. “If we had a 50¢ range in that loop, it would have been devastating.”
The CFTC is considering the imposition of mandatory pre-trade filters, price collars, trading limits, kill buttons and other measures proposed jointly by the FIA Principal Traders Group and the FIA European Principal Traders Association in March. Most futures exchanges say they’re already there, and both CME and ICE presented their risk-control procedures at the TAC meeting. Interestingly, neither exchange differentiates between algorithmic trading in general and HFT in particular when monitoring trades.
“We can be talking about something as simple as a spreadsheet to an auto spread to a sophisticated black box,” says Mark Wassersug, ICE’s vice president of operations. “All of them have direct market access. We do not look at subcategories beyond that.”
But they do monitor every order, every modification and every cancellation down to the millisecond and in real time. Both CME and ICE are able to reconstruct the entire order book over multiple markets and detect anomalies in real time, and both know an incredible amount about every single trade that comes in.
“When an order comes in to us, we get the clearing firm that is guaranteeing the trade, that trading firm executing it, the session ID, the account number, the country of origin,” says Dean Payton, CME Group’s managing director & deputy chief regulatory officer. “We also have the ATS order identifier, which we introduced last year, and the operator ID — or Tag 50 — which is the person who is entering the order into Globex. We have their names, we know who those individuals are. In the case of an automated trading system, you have a head trader, and you have the team of individuals who support that ATS. So you may have a risk manager, a secondary trader, a monitor — all of those folks would be registered with the exchange.”
Then there is price banding, which is designed to halt runaway moves. The CME had its Stop Logic function in place before the Flash Crash, and ICE implemented its Interval Price Limit (IPL) system after the crash. It’s a sophisticated limit-up or limit-down mechanism that puts a floor below and a ceiling above a market for a given time period. The floor and ceiling move slowly, and the market triggers a “hold” if the price hits either. During that hold, orders keep coming into the market, but bids are not allowed above the ceiling and offers are not allowed below it. The holds can last a few seconds or a couple of minutes, and then the bands begin moving again.
Such pauses provide an opportunity for living, breathing traders to think and react — and that, perhaps, always will be the ultimate safeguard against algos run amok.