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This Is What Happens When An HFT Algo Goes Totally Berserk And Serves
Knight Capital With The Bill

We all know something went horribly wrong in various NYSE-traded stocks
today between 9:30 am and 10:15 am. So wrong in fact that the NYSE had
to step in and cancel numerous trades in 6 symbols. However it did not
DK millions of other trades in 134 other symbols, the vast majority of
which we assume traded errantly due to the market making of Knight
Capital (as admitted by the company), which today saw its biggest drop
ever since going public on volume about 60 times greater than its
average. We also all know that one should buy low and sell high. At
least that is what human traders are taught, and that is what they

Because if one consistently does the opposite, one will simply run out
of money. Well, the opposite is precisely what the berserk algo in
Knight's Market Making group may have done if Nanex, which has done a
forensic analysis of one of the trades in question, is correct. In other
words, instead of at least attempting to provide liquidity via limit
trades, Knight's algorithm acted as a market order... gone horribly
wrong. As the third chart below shows what the algo did with furious
repetition and steadfast consistency was to buy at the offer, and sell
at the bid, in other words buy high and sell low. Over and over and over
and over.

As Nanex laconically notes, "In the case of EXC, that means losing about
15 cents on every pair of trades. Do that 40 times a second, 2400 times
a minute, and you now have a system that's very efficient at burning
money." Which also means that by not DK'ing several hundred million
prints, the NYSE may have just thrown Knight under the bus, because the
market maker is suddenly on the hook for tens if not hundreds of
millions in inverse market making profits.

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