Layering High Frequency Trading, depending on the strategies used, has a different effect on the market condition. Some of them are draining liquidity from the market, other – add liquidity to the market. Many of them are the cause of sudden unexpected movements in market quotations., and also generate new borderline methods of unethical, and sometimes illegal income generation on stock exchanges.
This controversial practice includes the method layering ( layering), the essence of which is to create the possibility of artificially shifting the quotations of purchases and sales of securities in order to force the rest of the exchange market participants to make a profitable deal for the manipulator.
Profitable dolphin
Predecessor layering can be considered the trading technique of trader Paul Rotter, used by him at the beginning 2000 years in derivatives markets for European government bonds. Paul Rotter is from Czechoslovakia, moved at the age of nine with his parents for permanent residence in West Germany. In his youth, he worked for several years on a bond desk in a Frankfurt bank. He quickly realized, which can trade independently and much more successfully and efficiently, than in the bank, since bank employees are limited by various requirements and control of the level of risks. Rotter c 1996 left the bank for the German derivatives exchange, where he became one of the largest individual traders, later he traded on the Eurex exchange.
His trading strategy was to very quickly place and withdraw large volumes of orders to sell or buy securities within the spread.. This caused a certain reaction from other market participants., who believed, that the reduction and shift to one side of the spread indicates the emergence of a large player, and they moved their trade orders to the side, needed by Rotter. After that, Paul Rotter sold or bought the security at the price, more profitable for yourself, than before your manipulations. Then, he began to cause a shift in trade orders in the opposite direction. Nobody in the market knew, who is behind this, but some traders assumed, that this is the same face. He was given the name Flipper, similar to the name of the dolphin in the movie, which the, as well as the unknown trader, jumped on the waves, appearing and disappearing in the market.
IN 26 years Rotter became a member of the team of traders at Greenhouse Capital Management, which was created by Kinski and Marenek in Irish Dublin. Later, Kinski talked about starting their joint business.. According to him, the initial capital of the company was $1,3 million. Traders were very risky trading, trading with all the capital, which had, fearing to lose it completely. But the risk paid off: for the first day of their work they earned $526 thousand, and the profit for the first quarter – $6,5 million. And although they worked together, Rotter became the main star among them.
Greenhouse grew rapidly and was successful, but its founders decided to dramatically increase the volume of operations, attracting capital for this on the stock market. The company tried to conduct an IPO, however, she did it at the worst possible time - during the collapse of many high-tech companies. Investment banks did not want to place securities of new corporations on the stock exchange at this time.. This led to the collapse of the company.
IN 2001 year the name of Flipper - Rotter became known and in the status of a famous trader he moved to live in Switzerland, where he created his company Rotter Invest. During this period, Rotter very rarely lost money on the stock exchange., earning around 55 million. euro per year. Professional media in 2004 named him the world's most successful individual trader. From that time on, Rotter began to give interviews and share his views on his stock trading..
The problem was, that Rotter's actions were regarded by many traders not so much as successful trading on the exchange, but rather as a manipulation of the stock market, i.e, conduct unethical and even, as maximum, illegal trade practices. His controversial actions caused heated discussions in the society of traders.. Some traders called him a genius, others considered his actions to be criminal market manipulation. Arguments, who spoke for and against its working methods, and are repeated today in relation to traders, practicing controversial trading methods on the exchange. There has always been a dilemma “on the one hand on the stock exchange, or you win, either lost money, on the other hand - "exchange – a place for fair trade ".
According to Rotter, these are all relative concepts and there is no borderline between manipulation and fair trade. Any trade order, any smallest trade affects the entire market. Therefore, the separation of traders' actions into exchange manipulation and fair trading is exclusively a question., related to the rules, prescribed by regulators and the exchange. And all, what is not prohibited – allowed. But who would, what opinion did not hold, predecessor creator leyringa Paul Rotter still thrives today, managing large capital from the canton of Zug in Switzerland.
The first punishment for HFT practice
Paul Rotter traded by hand early in his career, manipulating exchange orders with a frequency of once within a few seconds during the active phase of trading on the exchange. With the development of trading algorithms and the advent of robots for quick access to trading, this process was automated.. The result of these trends is modern layering trading technology., when, On the one side, trading operations are carried out in a split second, and on the other, they become victims trading robots other traders, not people.
The essence of layering is best illustrated with a specific example.. When layering was deemed unacceptable, then they began to investigate the activities of companies, practicing layering, and publish reports of these investigations. We will use one of the reports, to figure it out as accurately as possible, how manipulation is carried out on the exchange market.
This is best done using the example of the first case in the world., when an HFT trader was charged and found guilty of using market manipulation practices. The CFTC punished Michael Koscius, owner of Panther Energy Trading. His illegal operations concerned 18 futures contracts on CME (Chicago stock exchange), including metal futures, energy raw materials, agricultural products, interest rates, currency and stocks. The CFTC deprived his company of the profits made in $1,4 million, and also imposed a fine for the same amount and, Besides, Banned Kostia from trading on exchanges throughout the year. Except markets USA, Coscia successfully traded oil futures in London, on the ICE exchange, until they again became interested in the London regulator FCA. The trader was fined for 600.000 Pounds.
Consider, how Kostia traded
Initially, he placed a small real order at a price slightly above the current best futures buy price., and then began to place large fake orders to sell the asset, everytime, slightly lowering the price. For other traders, as a result of such actions in the market, the impression is made, that for unknown reasons there was a large offer for sale. Respectively, traders try to place a sell order as soon as possible, while prices have not yet dropped below. Considering, that Kostia had brought the selling price of the futures to that moment practically to the required level, the order of the next participant is executed by $115,86 real order Kostia.
A trade transaction is carried out in two stages: after the first stage robot A kostion of previously placed sell orders cancels. The best selling price of the asset returns to its previous level. In this way, the trader makes a deal at a price lower than the real market price at 3 item.
To make money on this operation, he places a trade order to sell the futures at the price $115,88, which is slightly below the real best current selling price in the market. Then it pulls up the best buy price of the futures to the required level again., consistently increasing the price by placing large fake buy orders. Other traders get the impression again, that there is a great demand for futures on the market and to buy an asset at current market prices, they are forced to quickly place their buy orders. Respectively, By this time, Kostia has raised the best purchase price to the level it needs, and the next order of another trader on the market fills his real order.
After the transaction, the Kostia robot cancels the previously placed buy orders, and the best purchase price, respectively, returns to the previous level. I.e, Kostia by placing false orders conducts a trade at a price higher than the market price by 7 points.
Notice (cm. "Time" in tables), the whole operation took a total of 0,6 seconds. In this way, a trader places fake buy or sell orders in large volumes, what is like layering them on top of each other and the real cost. Hence the name of this market layering manipulation – "Layering".
Use in trade layering carries a high risk of execution of placed false orders. Even considering, that these orders exist in tenths and hundredths of a second, a robot of one of the traders can manage to open a trade at a fake price. So, Michael Koscius had fake orders triggered in whole or in part in 3,5 % from all placed false orders. On the other hand, almost in 30% cases real orders were not executed.
Canadian giant Swift Trade
In Toronto in June 2002 the trading company Swift Trade was created with the participation of Peter Beck. Initially, this company was engaged in trading from the company's account using Beck's personal funds.. But in 2004 the business model has changed. Now this company was supposedly providing services to independent firms., trading, wherein, each of them, respectively, entered into contracts for servicing private traders around the world. Formally, the parent company provided its "corporate users" only with access to the exchange and the trading platform..
As it turned out later during the investigation of Swift by the British regulator FSA, the entire company network was controlled indirectly by Peter Beck, and all "independent traders" were actually his employees. IN 2007 year around the world in 150 outlets operated about fifty "corporate clients", which brought together about three thousand traders, engaged in intraday trading and did not have the right to transfer trading positions to the next day. Payment by traders for Swift Trade services consisted of 2 parts: 27% profit and regular payments for using the trading platform.
According to the reports of the British regulator with 1.01.2007 on 4.01.2008 the years Swift Trade "Systematically and deliberately" used layering, trading on the London Stock Exchange, and made a significant profit on this. Trading tactics were traditional for layering: traders in the order book placed many consecutive orders, slightly different in price from each other, for the sale or purchase of traded assets on the exchange, with no real intention to buy or sell an asset, but only by manipulating the interest in this asset of other traders.
Company tactics layering used very widely: number of fake applications, created by the company, there were tens of thousands. And the frauds were carried out by "independent" traders from various countries., far from American and British regulatory authorities. Proven, that all the actions of traders were directed by Peter Beck and his employees, and, the funds for these operations were provided by Beck himself through third parties.
In the UK, the Financial Conduct Authority found, that such trading practices can seriously undermine the confidence of traders in working in the financial markets. And the London Stock Exchange has expressed its concern over trading practices, used by Swift Trade. but, Swift Trade not only did not refuse from layering, but even started looking for ways to get around the restrictions imposed on its use, and started to improve the trading model, to avoid exposure. Swift Trade, while promising to increase control over their operations, changed the provider of direct access to trading to reduce the control of the regulator.
The new provider did not notice suspicious activity for a long time Swift. but, in December 2007 year, a special statement was published by the London Stock Exchange on the inadmissibility of using layering, and a month after the announcement, the London Stock Exchange stopped the activities of Swift Trade.
After that, Peter Beck transferred his network of traders to another legal entity - Biremis Corporation and expanded his activities to other markets, in particular, US markets. His network at this point included 30 countries of the world and was 5000 Traders, he provided his traders with access to funds in the amount of about $2,4 billion. The new company followed the same pattern, but improved trading algorithms and bureaucratic loopholes allowed Biremis Corporation to remain in the market until the middle 2010 of the year.
The activities of Biremis also came under investigation and at the end 2012 years, heavy fines were imposed on Peter Beck's company – about 8 million. Pounds, and Peter Beck was banned from working in the US stock industry for life.
but, despite millions in fines and constant struggle with regulators, Peter Beck has followers. In 2009-2010, the Hold brothers tried to create a similar network., who founded Hold Brothers for the provision of access services to stock market US foreign traders. But, and parent company, and her two "corporate clients", working with intermediaries, controlled from one center. This network was created specifically to create the appearance of fragmentation and randomness of actions from different parts of the world when trading securities according to this practice..
Hold Brothers traders in a year and a half, until the attention of regulators and exchanges is attracted, held 325 thousands of layering transactions, putting about 8 million. false orders, while receiving, illegal profit in the amount $1,8 million.
The final for this company was no less sad: the American Markets and Securities Commission fined the company and its key employees for 4 million. dollars and three of them, banned from trading in the stock market for 3 years.
Regulators versus layering
It should be noted, that any single operation within the framework of the layering practice is not illegal. Undoubtedly, any trader, has the right to place trade orders at any price he needs, and also remove them from the desk and do it quickly and often. I.e, on technical parameters, it is impossible to find fault with such price manipulations. Paul Rotter spoke rightly, that any action of a trader has, albeit very small, market impact. And it is technically impossible to separate standard actions from illegal practices..
But regulators have their own point of view. Daniel M. Hawkey commented on the decision to impose fines on Hold Brothers so: “Our markets are based on honest principles, which imply, that the price of securities is a reflection of the real supply and demand in the market. SEC calmly look at practices, violating this principle, will not be". I.e, the regulator means, what applications, put up to buy or sell an asset, mean the intention of the trader to conduct a real trade deal with a given volume of an asset at a specified price. Undoubtedly, the trader's intention may change, for which there is a mechanism for canceling the order. But the intention itself must exist initially. If the order on the exchange is placed with the aim of misleading other traders, it should be considered illegal.
Interesting rhetoric, used by regulators to practice layering. Studying the decisions of British regulators or SEC, the impression is made, that the practice of layering is almost worse than insider trading. Obviously, the novelty of this phenomenon lies at the heart of this attitude: if everyone is tired of the insider, then layering is of interest. So, supreme court of Great Britain, accepting the appeal of Peter Beck, in its ruling Swift Trade defined behavior as "a cynical sequence of intense manipulation", and Peter Beck's offense was defined as “extremely serious, as far as you can imagine ", considering this phenomenon "an insult to the rules and regulations of the financial market".
Now the position of the regulators of the exchange market is defined as clearly and unambiguously as possible.: in the stock market, layering is one of the most serious and serious crimes and will be seriously fought against. So,, more than once we will hear about multimillion-dollar fines and excommunication from trafficking of perpetrators.
