Wednesday, February 24, 2010

Is the $SPY getting a "Jump" at key levels from a quant algo? High Frequency Trading

One of three key market participants on the New York Stock Exchange (NYSE). Supplemental Liquidity Providers (SLPs) are market participants that use sophisticated high-speed computers and algorithms to create high volume on exchanges in order to add liquidity to the markets. As an incentive for providing liquidity, the exchange pays the SLP a rebate or fee, which was 0.15 cents as of 2009 Now read on.

I am growing more and more tired of seeing what appears to be a very "helpful" algorithm running in the SPY. I am using the term "helpful" very lightly. I relate this algorithm to a jumper cable, your car will run once it takes the jump if your battery is running low right?

Now lets say volume our current market is equivalent to a discharged but not quiet dead battery. Symptoms of the market being a "dead battery" are sluggish movement through key pivot levels on a daily 1 min chart, along with violent price spikes within the 1 min candle.

So how do you fix a market which does not have the Umph it needs to remain liquid while not remaining flat all day after the initial 30 min opening volatility? A quant algo of course!
 First a little background on why the SPY is be a good candidate(vehicle)for a bit of undercover manipulation. As you may or may not know ETF's run our retail markets. The S&P depository Trust buys and sells individual components of the S&P's based on movement within the index. Simple right? Well if you say, "Screw it, I am purchasing the 500 S&P components via the SPY ETF. 

Now i can buy little pieces of the components without laying out the cash to buy them individually." This is GREAT, *If you are a buy and hold investor looking to leverage your hard earned dollar. Now lets discuss how seemingly normal trading within the SPY is actually manipulation ...

*If there is a huge buyer day in & day out of the SPY whom has no interest in holding for a long period of time, how would this affect individual S&P500 components? The direct affect would cause the cash market(individual stocks, not futures) to trade in a seemingly natural liquid manner in whichever direction the purchaser is leaning.

Now for the juicy stuff...For months now i have been watching a specific algorithm push our markets around with great ease. It looks like this algo is giving the SPY a little "push" through support and resistance levels via massive size executed in seconds. Sometimes the push is tens of thousands of shares sometimes 100's of thousands, the size all depends on the natural volume around the level that may need a "Jump".

 For instance, if the market is oversold on a 1 min time frame trying to break higher off lows but just cant get the party going on its own, the algo will come in and take offers until day traders, scalpers and swing traders jump in chasing the market higher. Once the SPY takes the "jump" the algo simply sits and waits till natural buyers and sellers are few and far between, it then either dumps or takes in more. Usually the program will reset itself after a trade, to prepare itself for the next "jump".

The chart above is a illustration highlighting the algo in action. The chart includes Time & Sales which only display prints on the exchange the algorithm does business on. A specific exchange is used because of its very nice rebate structure, and it allows the algo to exploit the SOES, meaning it cannot trade in blocks larger than 1000 shares per order. 

How does it exploit?.. it takes blocks of almost 1,000 shares multiple times a second, this price action causes the market to lift violently. Orders of 1,000 shares or less get executed in front of institutional orders, very quickly. This is where the algo gets its ability to execute orders extremely quickly. Remember small money follows big money, this algo is big money, even though it breaks the orders up its positions can reach 250-500k shares in seconds.

The algo in question started buying at 110.04 with one block of 999 shares, followed by 60k shares all bought in under two minutes. You can see the SPY's reaction to this in the above chart, it violently moved higher all the way up to 110.55, where the algo dumped just about all of the shares, you can see these prints in the window labeled "dump", again these prints are only on the exchange the algo does business on. 

Whala, the algo did its job, the cash market snapped back from a free fall, individuals components again caught a bid and moved higher through resistance. I.E. the trading looked alive and well... Natural buyers came in above the 110.55 level chasing the market up another 50 cents or so before they left and the SPY fell again because the volume was not there to support the massive run up which took place in barely 15 minutes. As you can see the algo works in two capacities, it manipulates the market to the upside along with keeping S&P500 components trading in a liquid orderly "non flat" fashion.

The 650,000,000,000$ question now is.. What would our markets look like if this "jump starting" was not taking place every day? I think you know the answer.

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