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Hedge Fund Under Investigation after Algo Floods Oil Market with Orders

Hedge Fund Under Investigation after Algo Floods Oil Market with Orders

A high frequency trading firm based in Chicago is being investigated by the CME Group because back in February, it turned on an algo that in just 5 seconds, caused oil prices to jump up $1, says Reuters.

Get ready to have your worst fears about high frequency trading confirmed, because here's a story about how an algo gone wild flooded the oil market with orders, "choked," died, and caused a huge spike followed by an even bigger drop in the oil market.

Five seconds after the firm turned it on, they had to turn it off. The algo "choked," after it had already flooded the oil market with orders that made up 4 percent of average daily trading volume in the contract, and caused a brief 1.3 percent jump in oil prices, from $76.60 to $77.60.

The firm turned on the algo on February 3rd 2010 just before close. The following day, perhaps because the orders were unexplained, there was a 5 percent plunge in oil prices. And the day after that, crude fell further, to $71 a barrel, and volume touched a then-record high.

Reuters says the firm has been hugely cooperative with the investigation and actually brought the faulty trades to the attention of the CME Group as soon as they occured.

This case is fascinating because the faulty algo's strategy is explained in detail. Firms are very secretive about what strategies their algos are designed to execute. So we're lucky to witness an open investigation like this in which an algo is dissected.

It looks like Reuters got to review tons of documents that detail how the algo was intended to work, what caused it to "choke," and the huge effect the algo made on the oil market in just one day.

From Reuters:

[Infinium Capital Management used a brand new algo] to execute a "lead/lag" strategy between an exchange-traded fund called United States Oil Fund (USO.P), which tracks oil prices, and the U.S. crude benchmark future, West Texas Intermediate.

The algorithm was turned on at 2:26:28 p.m. (Eastern) on Feb. 3, less than four minutes before NYMEX closed floor trading and settled oil prices. It immediately started uncontrollably buying oil futures, according to the documents, which include letters from Infinium's lawyer to the regulation unit of CME Group, and cite notes from a company developer.

Infinium placed 2,000 to 3,000 orders per second before its flooded order router "choked" and was "dead in the water" a few seconds later, the developer's notes said. The algorithm was shut down five seconds after it was turned on.

By then, the documents show, the firm had sent 4,612 "buy limit" orders into the market. It quickly offset the position, mostly with large "block" trades in the next few minutes, leaving it with a $1.03-million loss. Infinium's burst of buying and selling represented about 4 percent of average daily trading volume in the contract, and caused a brief 1.3 percent jump in oil prices, from $76.60 to $77.60, before settling at $76.98, Reuters data show.

Trading volume spiked nearly eight-fold in less than a minute -- and the reverberations turned some heads.

The next day, Feb. 4, commodities traders struggled to explain a 5 percent plunge in oil prices, the biggest one-day drop in half a year. On Feb. 5, crude fell further, to $71 a barrel, and volume touched a then-record high.

Apparently Infunium believes the algo one main flaw. It allowed thousands of orders per contract (even though they planned for it to allow one). Another flaw was with Infinium's computer, which they told Reuters may not have properly recorded the orders.

What happened to Infinium's algo is a great example of why many people are concerned about high frequency trading and algos.

Infinium's mistake might be compared to just a fat finger, but they're currently being investigated for market manipulation (although they probably won't be found guilty of it). The person or people who designed the algo are no longer at Infinium.

By. Courtney Comstock




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  • Anonymous on August 26 2010 said:
    Is that like when the Analyst "experts" get the $pOIL inventory draw-down data wrong, right before the gov't releases their own official (unmanipulated) data... sending $pOIL down fast where the little sheeple on leverage are forced to sell, right before the "big boys" with the big firms move back in with massive buy orders, sending $pOIL much higher than before the official gov't data was released?I wonder who knows a Middle East war may be in the cards? Maybe some guys at GoldSachs & the FED?? After all... they have to protect their own long-term interests to pay back all that free "gov't" money... right? (I mean the FED'$ Big Ben Bernie-nanke Bucks or "notes")What if Israel discovers the Mother Lode?

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