Man vs. Machine…Phase Three Underway?

by Kevin D. Freeman on August 5, 2011

CNBC mid-day reports today featured Jon Najarian commenting on how unusual recent High Frequency Trading activity has been this week. He gave one example that he described as another “flash crash.”
Najarian is a very good analyst and watches option trading closely. He comments regularly on CNBC. His thoughts support what we have been seeing. Much of the sharp decline this week was pushed by High Frequency Trading by algorithms. The Dow fell almost 1,000 points from the open on Monday through the lows this morning. This is very reminiscent of the “flash crash” that took place last May when the Dow dropped almost 1,000 points in a few minutes before rebounding.

The market has since rebounded sharply, climbing about 400 points from the bottom so far based on news from Italy and the EU that they are willing to take further steps to address the issue.

What we are noticing, however, is the extreme impact of computer trading. We have already demonstrated that such trading could be compromised by financial terrorists. [Note that this is our belief and not commented on by Najarian. He simply discussed the High Frequency Trading aspect.]

In 2008, we saw a combination of naked short selling and naked credit default swap buying. This combination pushed Lehman and others over the cliff and took the global economy to the brink of depression. The recent activity is very similar but seemingly enhanced by High Frequency Trading.

Here are a few key posts to review:

Why Bring in the NSA?

NASDAQ Admits Hacker Attempts, But Told to Keep Quiet

What Caused the 2008 Stock Market Crash?

Hacked! When will we start to defend America’s computers?

The Risks Remain

Italy in the Crosshairs: It’s only a matter of time

Can Wall Street Be Manipulated?

The Risks of a Splash Crash

From the “splash crash” post:

Now, there is a report published in Barrons that helps bridge the gap with clarity. Here are some excerpts:

HIGH-SPEED COMPUTERS TRADING millions of times a day on multiple exchanges around the globe have in effect linked once-disparate markets into an unstable, volatile whole.
ome of the programs even react to breaking news stories, translated for their
consumption into algorithms by companies including Dow Jones, the parent of Barrons, and Reuters. Each second, these talented robots monitor dozens of pricing relationships for multiple securities and commodities on many exchanges and buy or sell whenever an arbitrage opportunity arises. Many of the machines are plugged right into the exchanges’ computers to give them an extra speed advantage. They need it. Some of these opportunities are so fleeting—we’re talking milliseconds—that they are invisible to us mere mortals.

The machines typically hold the stocks from two to seven seconds, realize a portion-of-a-penny profit, and repeat the process, over and over. The pennies accumulate into astronomically large heaps. Estimates of the unregulated, secretive industry’s profits for 2009 ranged from $2 billion to $5.6 billion.

Oversight of robotic trading is so slight that regulators have little idea of its impact. Progress Software’s Bates frets that, absent more oversight, terrorists wielding the smart machines could attack the markets in an attempt to cripple our economy. Regulators counter that it would be much more difficult for hackers to infiltrate a stock exchange than, say, a company like Sony (SNE), the recent victim of a crippling criminal cyber attack. But it isn’t impossible. Imagine an agent working for a foreign government infiltrating a firm that owns robots and infecting one or more of the machines with a malicious virus.

There’s also circumstantial evidence that some of the robots are mechanized Ivan Boeskys, attempting to manipulate prices. “Everybody knows it,” says Bates. “The regulators know it. So do the exchanges. They should begin actively policing trading.”

Bates isn’t a lone voice. Other market experts agree that a bigger flash crash is possible. Joe Saluzzi of Themis Trading in Chatham, N.J., warns that fixes like the circuit breakers are Band-Aids: “Even if regulators had their 10% limit-up/limit-down circuit breakers in place for all stocks, the market could still drop 10% in a matter of seconds or minutes. This will shatter already-fragile investor confidence.”

There is growing evidence that Phase Three is underway using the weapons of Phase Two with the intention of attacking the global currency system and sovereign debt. The question we must ask:  Who is looking at the possibility that this is terrorist activity? We have already demonstrated motive, means, and opportunity.


All posts Copyright (c) 2011 Kevin Freeman, All Rights Reserved

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