High-frequency trading in the U.S. equity markets continues to result in strange price movements, raising concerns about the interaction of technical glitches, fat finger errors and algorithms in the electronic markets.
Price moves in U.S. stocks that appear to drop or spike upward for no particular reason, only to rebound a few seconds later, have become a daily occurrence in computer-driven equity markets.
[Read: Fallout of the Flash Crash -- One Year On to learn more.]
In the past few months, these events have impacted brand-name stocks, including Berkshire Hathaway, Home Depot, Disney, Amgen and J.M. Smucker.
Some market observers have dubbed these incidents mini-flash crashes -- a name derived from the May 6, 2010, "flash crash," when the market plunged nearly 700 points and then quickly recovered by the same amount in a matter of minutes.
"That's the one thing since the flash crash that we haven't gotten a handle on and it continues to plague us today," says Christopher Nagy (Twitter: @christophernagy), president and founder of KOR Trading, an Omaha, Neb.-based firm that focuses on market structure and regulatory issues. "It's broad based. From one day to the next, one stock to another, the incidents tend to happen as volatility picks up multiple times a day."
Most of the sudden price moves that occur every day are flying under the radar of the circuit breakers that exchanges implemented following the flash crash. In these instances, Nagy says the stocks may be moving violently, but they're doing so beneath the range that would trigger a trading stoppage.
According to Eric Hunsader (@nanexllc), chief executive of market research firm Nanex LLC, these distortions in price impact both large and small company stocks, and occur on all the exchanges. They can happen for a variety of reasons, including a reaction to news or earnings results, or someone mistakenly using a market order that wasn't intended.
"They just get eaten alive," says Hunsader, whose firm tracks high-frequency trading as it occurs across the 13 stock exchanges and dark pool trading reporting facilities. "Sometimes it's algorithms that are feeding off each based on input prices."
On the heels of Facebook's disastrous IPO in May and Knight Capital's near demise from a software error on Aug. 1, these mini-flash crashes are garnering attention. But exchanges do not publically release data on these events, industry sources say.
Both Nasdaq and the NYSE did not respond to interview requests for this article.
Flash Points: Liquidity Vacuums
Critics of the current market structure blame the mini-flash crashes on high-frequency trading firms withdrawing their liquidity for a short time.
Arnuk, whose firm follows these events, often pointing them out on Twitter, says there is typically some type of stress that induces the move. He cites the recent example of Home Depot, whose stock saw a big spike in volume, plunging 80 cents from $63.50, and then returning to that level in less than two seconds. But Arnuk also maintains that high-frequency traders, who are now the primary liquidity providers in the U.S., are the cause of such incidents.
"They are playing a game of trying to maximize their positions to gain a rebate. They want a bid in the stock when they have a very high probability that they will be high in the queue coupled with the same side and the same price," he says.
"Basically, they have a guaranteed profit. It's risk-free and guaranteed economics, guaranteed by the stock exchange. Firms make 33 cents per 100 shares for providing liquidity and then turn it around for 20 cents."
He continues: "Technically, it's trading. HFT shops would like nothing better than a stable Bank of America, KeyCorp and Boeing -- large stocks that they can flip all day long. What happens with the mini-flash crashes is there is a period of stress and that stability becomes uncertainty. Frequently it will be the result of a fat finger error."
Arnuk contends that liquidity vacuums often ensue following a disruption in stability, which can also be the result of a news event hitting the wire. "The ability of these guys to gap a stock and yank liquidity is frightening," he argues.
Traders are also concerned that spikes caused by earnings or company news have become more extreme.
"Stocks have always reacted to news, whether it was earnings or a story like Apple's, like we saw with Pandora's. But the moves seem to be exacerbated by the high-frequency trading," says Peter Lobravico, a seasoned trader who's been in the business for 14 years.