An Urban's Rural View

Michael Lewis, author of such memorable books as Liar's Poker, Moneyball and The Big Short, has asked the question of the week -- maybe the year.

Authorities in England had just arrested Navinder Sarao for manipulative trading that they allege helped cause the 2010 "flash crash," in which the Dow Jones Industrial Average kerplunked 1,000 points in a matter of minutes (http://tiny.cc/…). Which occasioned Lewis, in a column for Bloomberg, (http://tiny.cc/…), to inquire:

"How can a guy working from his parents' house in suburban England whose only actionable orders were to BUY stock market futures cause such a sensational collapse in U.S. stocks?"

Lewis isn't suggesting the authorities nabbed the wrong guy, mind you. He's wondering how someone using what the Wall Street Journal called "a souped-up version of commercially available software" tricked the market into falling so spectacularly by placing a series of orders on stock-market futures and then cancelling them? How could his "spoofing" have gone unnoticed by his broker, the exchange, the regulators? How, in particular, could this lone day trader have outwitted the big Wall Street supercomputers with their sophisticated high-speed trading algorithms?

"Stupidity isn't a crime," Lewis wrote. "Still, it would be interesting to know who, at this particular poker table, on this particular day, was the fool."

Even as Lewis' questions go begging for answers, farmers might well pose a question of their own: How susceptible are the commodity markets to big-time manipulation, either by little guys with "souped-up software" or big guys with high-speed algorithms?

Some quick history: In the vocabulary of DTN's Six Factor approach to markets, farmers and grain elevators are "commercials." Their primary business is the production and sale of the underlying commodity; their trades are mostly hedges. The "non-commercials" are speculators. The liquidity non-commercials provide lubricates and sometimes moves markets, but back when the trading was done on the exchange floor, their ability to manipulate markets was limited.

Then came three big changes. One was the rise of a new class of non-commercials -- big financial funds looking to diversity into "alternative investments." Another was the advent of electronic trading. The third was a new twist on electronic trading, the high-speed computer trading driven by algorithms that DTN Senior Analyst Darin Newsom refers to as "Watson," after the IBM creation that answers Jeopardy questions and defeats world champions at chess.

As Darin pointed out in his most recent column (http://tiny.cc/…), the big investment money moves markets as much as ever, maybe more. Corn futures, in Darin's technical analysis, ought to be rising. They aren't, he says, because the non-commercials have been trimming their net-long position.

Moving markets, to be sure, isn't the same as manipulating them. And while manipulation surely happens -- see, for example, this civil penalty (http://tiny.cc/…) imposed last year on oil-market manipulators -- there's no evidence that anybody has been able to do to the commodities markets anything remotely like what Navinder Sarao allegedly did to the stock market.

Still, markets are markets. And as Nasdaq's chief executive told the Wall Street Journal, exchanges need to "assume the worst" (http://tiny.cc/…).

"Our view is you have to assume there's a trader sitting in some house in London or Singapore or Podunk, Iowa, trying to do bad things in the market. We have to build our defenses and infrastructure around that perspective. We need to be paranoid."

That's not an answer to Lewis' question but it's a sobering thought.

Urban Lehner
urbanity@hotmail.com

(CZ)