It is clear to me that Bloomberg reporter Matthew Philips does not understand what he is writing about in his story about Don Wilson and his conflict with the CFTC. Mr. Philips tries to frame this story in his lead paragraph as the “opening salvo” between the CFTC and high-frequency traders. It is not. He is wrong.

So let’s dismiss this argument first. There is no high-frequency trading in swaps trading. Period. Perhaps when we get the SEFs fully up and running and all potential swaps dealers are registered and participating, then we could see some HFT. Until then, this is an erroneous backdrop. Most swaps trading takes place over the phone and the SEFs are just getting started to trade them electronically. Take a look at the volumes on this webpage from Markit about CDS and tell me how much HFT you can get for these swaps that trade mostly single digits on a weekly basis.

Lastly, the idea in injecting and cancelling thousands of orders a minute, as traders using HFT techniques do, is to detect directional influences of the order flow. If there is no to little order flow, there is nothing to detect.

So, since there is no HFT in swaps trading, Don Wilson could not have been, and was not, trading that way and thus this reference is irrelevant. Wilson is an options trader who has gotten into other types of markets and asset classes. He does engage in some HFT, but it is not even a majority of what he and his firm does.

This case is a perfect example as this was a position trade. This was a spread trade of a futures versus a cash product. The position was established and Wilson continued to bid on additional size.

Philips wrote that according to the CFTC, Wilson used a technique called “banging the close” in order to manipulate the market. He says a firm “will put on a position in a particular market and then use a flurry of fake orders at the end of the day to move prices in its favor.”

I am insulted when someone says “fake order.” All orders placed in an electronic market are “actionable.” These orders were actionable even if there was little participation in the market from other traders. There was nothing fake about them. Each one could have been executed. There were a limited number of market participants, but that is the nature of new markets, or event some OTC markets. Philips needs a basic lesson in electronic trading and how it works.

He goes on:

By December 2010, the price of the contract hadn’t moved much, largely because “significant trading never materialized,” according to the complaint. Also, interest rates weren’t budging in any market back then. According to the complaint, “Wilson and DRW took matters into their own hands” and “developed and executed a manipulative scheme … by injecting bids that DRW knew would never be accepted, and in turn increase the value of DRW’s positions.”

OK, so you have a market that is largely illiquid and there are little to no factors to make it move, it is not going to trade. Any market works that way. What happened in hogs when the government shut down and did not report cash prices? Trading slowed significantly.

Wilson offered consistent prices in these contracts throughout the day via phone and then electronically. He was trying to get market participants to engage electronically, or get more market participants to engage, by offering actionable legitimate electronic orders. This is a logical pattern for a market to develop these days.

There is another side to this story, which is interesting. Don Wilson told the other side of the trade why they were wrong about their valuations in a white paper, sponsored by DRW. Subsequently, the market remained illiquid or became even more illiquid, after the paper was published.

If Wilson was wrong, then peer review of the paper would have corrected the conclusions he made. Did Jefferies or other counterparties engage in peer review?  If they did, I have not seen it. Rather, some counterparty complained to the regulators and all ultimately got out of their position. If they had reason to believe they were academically correct, they would have added to the position, not exited.

Here is a quote from the synopsis of the white paper:

Using a Hull-White model calibrated to the market data as of December 2010, we find the difference between the IDCG futures swap rate and the corresponding uncleared swap rate to be around 18 basis points for a 10 year contract and about 60 basis points for a 30 year contract. An interest rate environment with higher volatility will result in larger differences.

Here is the reason Wilson believed the swaps were worth more than the other participants. Putting bids and offers in the markets where you believe fair value is at is what traders do every day. Telling the other side of the trade why they are wrong is not something done every day, but is honorable and helps a market grow.

Philips goes on:

The idea of a Bang the Close strategy is to fake the rest of the market into thinking there is a big order coming down the road and that prices are going to move in one direction or the other.

No, the purpose of bang the close is to get a favorable settlement price. The suggestion of a big order coming down the road is pure illogical supposition and nothing in the CFTC complaint suggests that. Besides, the market is closed.

He goes on:

HFT firms that are good at Banging the Close can fire off thousands of orders in a few microseconds, only to cancel them just as quickly.

Yes, HFT firms can fire off thousands of orders in a few microseconds, but HFT firms do not as a rule bang the close because most HFT firms are day traders who are flat at the end of the day. There is no reason to try to get a favorable settlement price. I might even guess that HFT firms might even take the foot off the gas nearer the close because they don’t want to get caught with a position. Thus the whole HFT bang the close idea is just horse hockey.

For the record, when I say HFT firm, in this case I am talking about market-making firms that use HFT tools as a way to participate. There are long-term directional traders who use HFT tools too, which could have an interest in the closing price. Should a directional trader engage in high-frequency orders to influence the closing price, it would be very noticeable.

Philips continues:

The intent is to give other traders the false impression that lurking behind all those orders is a huge institutional player coming into the market to either buy or sell. As a result, people want to get out in front of that big order and buy up contracts they can later sell to that big buyer for a slightly higher price. The result is that prices can jump more than they would’ve otherwise.

I am so confused by this, I don’t know where to start. Why is a person getting in front of a large order on the close of trading?  There is no later when the market closes.

Philips continues:

The CFTC alleges that DRW put in lots of fake bid orders at higher interest rates to try to drive the price of the futures contract higher.

Wilson and DRW traded on the phone market and put orders in the electronic markets. The levels were consistent spread prices. The prices they offered throughout the day did not change, just the trading method/venue they offered them on. DRW did not even write to the electronic match engine used and used a third-party platform to enter orders.

All orders were actionable, not fake. The CFTC says Wilson entered orders that DRW “knew would never be accepted.”  That is a large assumption for trading from January 2011 to August 2011. The orders were cancelled after the markets closed as they were part of a spread.

Philips does offer:

“In this case, DRW’s orders were entered more slowly over a longer timeframe, though the CFTC complaint focuses on a 15-minute window when the contracts settled each day. The strategy was executed over the course of at least 118 days, according to the complaint, and netted DRW “unlawful profits of at least $20 million.”

So all this stuff about HFT WAS not relevant, which begs the question why he used it.

If I was going to write this story, it would have started like this:

Don Wilson, a marathon-running bicycle enthusiast trader from Chicago, took the wrong path according to charges brought by the Commodity Futures Trading Commission.


Don Wilson, a marathon-running bicycle enthusiast and world class sailor, took the wrong tack in the market, according to charges brought by the Commodity Futures Trading Commission.

If the writer wanted to write about extraneous issues to frame a story, or cliche, a little research into Don and his interests would have given him plenty of choice. Instead, we got an ill-conceived, illogical and badly researched piece which piled onto the negative ill-informed press high-frequency trading regularly receives. And it besmirched the reputation of an honorable man while not telling the whole story about the conflict with the CFTC.

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