Sal Arnuk, partner and co-founder of Themis Trading LLC, discusses high-speed trading and its effect on the markets this afternoon on CNBC.

To fix the markets, Arnuk suggests eliminating payment for order flow, restricting some information from being disseminated in proprietary data feeds and overhaul order types.

Watch the video to see the whole segment, in particular the part around 1:50 where he notes the distinction between volume and liquidity.

We live in a brave new world: bombarded by news, data, and information from other sources, such as e-mail and social media. People cope with the volumes of data in different ways: some turn off e-mail after hours and on weekends, some ban selected channels like television (me!), still some take it all in. Dealing with increasing amounts of data has generated its own scientific category: Big Data. In investment and trading industries, the big data science becomes the Big Data Finance.

Big Data Finance is not ultra-new. Quantitative hedge funds have been using Big Data Finance since these large data sets became available. Sophisticated hedge fund brokers have been parsing data using Big Data Finance techniques to achieve optimal execution. Databases, data-processing tools, even high-frequency trading (HFT) are all manifestations of Big Data Finance that have now been around for a while semi-autonomously. Now, all the Big Data Finance techniques and trends are brought together and formalized in academia (see www.BigDataFinanceConference.com ).

Treating Big Data Finance as a science is important. For one, it is critical to separate legitimate methodologies for distilling valuable data signals from meaningless “spurious” noise derivations. Methodologies for advanced identification of information in reams of data—say, methodologies based on eigenvalue computations—help investors identify true signals in the drowning din of noise. Spurious signals are often a result of “data-mining” activity, otherwise known as “spaghetti principle” that is analogous to throwing a plate full of spaghetti onto a wall and seeing what sticks. Spurious derivations such as the ones obtained from thoughtless data mining can destabilize the markets.

At present, both meaningful and meaningless analyses can be practiced in large institutions and small ones alike, in part because the unifying science of Big Data Finance is still relatively new, and the quality controls of data analytics are still applied haphazardly. As the market participants increasingly transition to the quantitative data universe, if not by choice then by necessity, Big Data Finance will be de rigeur subject to know and to apply.

Irene Aldridge is an Industry Assistant Professor of Finance and Risk Engineering at New York University (Poly), as well as Managing Partner at ABLE Alpha Trading, LTD. Irene’s new book, High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems has been translated into several languages and is being published by Wiley in its second edition at the end of this month.

The fastest growing segment of the financial services industry was the one hardest hit by MF Global’s suspicious demise and overt fraud at Peregrine Financial Group (PFG).

The managed futures industry, which had grown from $14 billion under management in 1991 to over $329 billion to end 2012, was a shining star of the new economy. Offering the unique ability to zig when other investments zagged, the lack of correlation and performance during crisis were key points of attraction. This attraction came to a screeching halt with the MF Global and PFG criminal incidents. Not only were investors getting acquainted with the asset class shocked to learn their accounts were looted of assets, but more troubling criminal behavior appeared the cause - casting a shadow over all participants.

“There is a severe loss of trust, a loss of confidence. There is incredible anger and frustration. Things need to change,” said Diane Mix Birnberg, president of Horizon Cash Management. Her firm just released a study, The Aftermath of MF Global and Peregrine Financial Group Meltdowns: A Crisis of Trust, showing that a whopping 91% of respondents believed there was a breakdown in audit procedures.

The study themes that emerged included:

• The laws and rules that govern the industry need to have ‘teeth’ – and those involved in fraud and theft need to be punished.
• Customer segregated funds must either be kept completely out of the FCM and/or be verified in real-time by regulators.

A strong and rare female voice inside a Type A male dominated industry, Ms Birnberg’s firm, Horizon Cash Management, has become the top cash management firm for participants in the managed futures industry. Starting in the 1970s as a secretary in a stock brokerage firm in Atlanta, where “women generally didn’t think about career aspirations,” she later joined Lehman Brothers in the bond business. After moving to New York City to work on Wall Street, she was recruited in 1980 by investors to operate a cash management firm in the futures industry and in 1991 founded Horizon Cash Management, which currently has $2 billion under management.

In MF Global “there was very little institutional leadership (from exchanges, regulators and major firms),” she said. “This resulted in rumor, innuendo and ultimately a lack of trust. The void in leadership is terrifying.”

Looking back on the MF Global and PFG disasters, Ms. Birnberg has the experience of witnessing 10 FCM implosions. “In every FCM implosion it has negatively touched the CTA / CPO segment of the industry.”

“Think about a plane crash,” she said. “When it happens? Key issues and facts are addressed by the airline, the FAA and even the US president. Information is available regarding what happened, why it happened and steps being taken to address the problem.”

With MF Global a plane crashed and there was silence.

This is the first part of a two part article.

Mark Melin is author of three books and taught a managed futures course for Northwestern University’s Executive Education program. To read additional blog posts visit www.UncorrelatedInvestments.com (requires free registration).

How does one define a previously un-definable topic such as High Frequency Trading (HFT)?

Sources close to the Commodity Futures Trading Commission (CFTC) indicate new thinking may be underway regarding the topic of High Frequency Trading (HFT). Speculation is this thinking could look at the relative market impact HFT may have in a given market move as a legal definition. Such a definition could consider the relative impact of a particular HFT player as a percentage of a market damaging move and could be used for potential CFTC action on the issue. This new thinking could be outlined sometime in March, sources said.

Current US regulation regarding HFT is considered by some market participants to be behind the curve relative to the European Union. In the EU, for instance, algorithm type is used as an identifier to determine market participant behavior during crisis conditions.

“There is significant uneasiness on the speed in markets,” noted Vassilis Vergotis, Executive Vice President, Head of Eurex, Americas.

For the full article, visit the source web site (requires free registration): http://www.uncorrelatedinvestments.com/blog/?p=59

Mark H. Melin is author of several books, including High Performance Managed Futures and taught on the topic at Northwestern University’s Executive Education program

NYSE Governor Peter Costa and former Security Traders Association president Joe Cangemi discuss the effect of high-frequency trading on the trading floor and say they see aggressive moves back into equities.

You can tune in to all of Reuters Insider’s exclusive GAIM 2013 coverage by clicking here.

Reuters’ Jennifer Ablan and Breakingviews’ Antony Currie say that, after Moody’s downgraded ratings for several banks, the debt is still a more attractive investment than the stock. (more…)

Former FDIC Chair Sheila Bair says big banks should separate their safe and high-risk trading operations into subsidiaries. She adds these units should have their own management boards. (more…)

Commodity Customer Coalition founder James Koutoulas is requesting that MF Global bankruptcy Judge Martin Glenn investigate three potential legal issues that are said to have occurred in transferring of MF Global assets.  The key issues include the fact that JP Morgan was able to purchase MF Global bonds at a discount without any open bidding process and the assets were apparently sold without disclosure to or approval from the U.S. bankruptcy court or trustees.  The third issue centers on JP Morgan seeking special favors from the Federal Reserve to receive priority treatment over investor segregated fund accounts.

The first such non-transparent movement of assets occurred when JP Morgan is said to have purchased MF Global’s Sovereign Debt at a significant discount without an open bidding process, paying $0.89 and later selling that debt to investor George Soros for $0.95.  No one is going to complain about JP Morgan generating profit.  However, purchasing assets of a bankrupt firm without an open bidding process or disclosure to the bankruptcy court and trustees is where JP Morgan may be in trouble, according to Mr. Koutoulas.  This sale could be subject to clawback provisions, legal experts speculate.  (On December 9, 2011 The Wall Street Journal reported the fact that bonds were moved to KPMG London office, which was the bankruptcy administrator, but at the time the article did not discuss sale details or approval through the bankruptcy process.  See “Corzine’s Loss May Be Soros’s Gain” by Gregory Zuckerman and Dana Cimilluca.)

The key issue is that such transfers is the bonds were purchased at a discount without open bidding and the process was not disclosed to or authorized by the U.S. Bankruptcy Court, according to Mr. Koutoulas.  “Who gave JP Morgan permission to purchase those bonds at a discount without open bidding?”

The second questionable movement of assets is said to have occurred when JP Morgan purchased MF Global’s stake in the London Metals Exchange (LME) without proper disclosure.  The event was widely reported at a basic level on November 28, 2011.  The larger issue, however, appears to center on the fact that such a transaction was not approved by the U.S. bankruptcy court and trustee.

“Was this disclosed in court?” Mr. Koutoulas rhetorically asked.  “No.  Was their trustee approval?  No.”

The third issue occurred in congressional testimony Thursday, December 15, 2011 where it was discovered JP Morgan asked the Federal Reserve to write a letter claiming that the segregated funds should not be categorized as client money.

“How many letters like this have they asked for in the past?  I want all the statistics regarding the number and content of letters,” Koutoulas questioned.  “JP Morgan wanted a ‘get out of jail free card’ from the Fed.  Guess what?  That doesn’t fly with me.”

“Their hubris is so severe.  They think we don’t know the industry, like we are Occupy Wall Street radicals or something and don’t have a clue or message,” Mr. Koutoulas said, noting that the CCC is comprised of experienced industry participants who understand the financial services industry from the inside.

Mr. Koutoulas seeks to solve the problem with JP Morgan without dragging the issue through court.  In speaking to JP Morgan, Mr. Koutoulas said “Listen, you are buying vulture MF Global claims at $0.86 ½ on the dollar.   Why don’t you pay a fair price of $0.97 ½ take the customers out of the bankruptcy and we will indemnify you from any class actions resulting from this.”  A vulture claim occurs when an MF Global claimant such as a farmer or small business person is in desperate need of cash and sells their claim to someone such as JP Morgan, who purchases the claim at a lower rate than the value at maturity.  In this example if JP Morgan purchased the claim at $0.87 and all clients were eventually “made good” JP Morgan would receive the par value of $1.00.  With the MF Global bankruptcy proceedings apparently moving along much quicker than expected, JP Morgan stands to potentially make a quick 13% return on such vulture claims.

Mr. Koutoulas reports that JP Morgan would not even discuss the issues.  “I can see that you disagree with me,” said Mr. Koutoulas, whose organization represents over 7,000 MF Global clients, mostly professional investors.  “They won’t even meet with me and talk with me.”

Mr. Koutoulas is currently working Pro Bono and many of the lawyers are working at a highly discounted rates and requested that industry participants donate to help .  “I need professional litigators and bankruptcy attorneys backing me up,” said Northwestern Law School grad Koutoulas who also operates Typhon Capital Management, which is an NFA-registered Commodity Trading Advisor and Commodity Pool Operator.  ”We’ve had an outpouring of lawyers who want to help,” Mr. Koutoulas said, sitting with a young Yale Law School grad as we spoke.

In calling on MF Global presiding bankruptcy Judge Glenn to investigate these issues, Mr. Koutoulas is rallying the futures industry to boycott use of JP Morgan.  “Call your FCM and if they are using JP Morgan say ‘We won’t do business with you if you work with JP Morgan,’” he said, requesting that industry participants get on Twitter and follow the #BoycottJPM hash tag.

For additional information on the Commodity Customer Coalition visit www.CommodityCustomerCoalition.org and on Twitter use hash tag #boycottJPM

For a related radio interview: http://bit.ly/vGsnh2

Mark H. Melin is author / editor of three books, including High Performance Managed Futures (Wiley, 2010) [http://amzn.to/vyonBA] and was an adjunct instructor in managed futures at Northwestern University.  Follow him on Twitter @MarkMelin or visit www.Go2ManagedFutures.com for additional information.

Risk Disclosure: Managed futures can be a volatile investment and is not appropriate for all investors.  Past performance is not indicative of future results.

The opinions expressed in this article are those of the author, may not have considered all risk factors and may not be appropriate for all investors.

Traditionally staid and conservative firm seeks buyers as concentrated bets in European Sovereign debt markets go badly wrong

Opinion:

In an episode of art imitating life, the movie Margin Call depicts a financial services firm that concentrated all its risk in one sweeping bet that went badly wrong. In the case of the movie, the trade that exploded in the debt markets of 2008 forced a financial services firm to liquidate assets in an attempt at survival. Fast forward to October 2011, and MF Global, one of the industry’s leading Futures Commission Merchants (FCM), is struggling for survival as it receives a real life margin call. As of this writing the New York Fed suspended conducting business with the firm and more significantly the CME Group has cut off trading access to the firm.

The eighth ranked FCM in 2010 with $8.6 billion under management, MF Global was, like many futures brokerage firms, following staid and conservative management principles that generally didn’t gamble company assets through proprietary trading. (In 2008 when a rogue Wheat trader made headlines by racking up $145 million in losses, such unauthorized trading wasn’t part of the firm’s management plan.)

Things changed rather dramatically during spring of 2010. This is when a gambler took the reins of power. As a result, the company is currently scrambling for liquidity to raise cash while its leader, former Goldman Sachs superstar Jon Corzine, might be looking at the numbers to figure out what went so very wrong. This might be similar to 1994 when Mr. Corzine was co-lead of Goldman’s fixed income group when it posted losses that almost took down the investment bank. But upon reflection, it looks more like the 2008 car wreck then NJ Governor Corzne was in while speeding down the expressway without a seat belt.

What Went Wrong?

With a University of Chicago background, a school known for producing strong quantitative minds, Mr. Corzine really needs to look no further than another U of C alumnus, Nobel Prize winner Harry Markowitz, to figure out why things went so bad so quickly.

As MF Global, one of the leading brand names in the futures and options industry, fights for oxygen and liquidity, Mr. Corzine’s significant concentration of risk towards a single market move in Sovereign debt highlights what is known as investment concentration. This means all risk in a portfolio might be influenced by one significant macro global force. In this case, when the credit markets in Spain, Portugal and Ireland logically fell apart without significant austerity measures in place, the bond investments and the fortunes of MF Global all lost value at the same time. This investment concept stands in contrast to Markowitz, whose Modern Portfolio Theory promoted the concept of asset diversification of returns streams, a cornerstone of proper derivatives risk management. Mr. Corzine might have missed that diversification memo.

There are several points of derivatives risk management Mr. Corzine and his well connected crew have ignored. Perhaps the most significant also was related to a debt issue. While at Goldman Sachs, Mr. Corzine and those designing non-transparent derivative products were witness to a warning from a demure female with a powerfully strong will: Brooksley Born.

Ms. Born was CFTC Chairwomen when, in 1998, she sounded alarm bells regarding non-transparent and toxic derivative products that were not managed in accordance with open, transparent and regulated rules that existed in the exchange traded derivatives markets. While she and her prophetic call for transparency into toxic assets were generally ignored – and she was effectively muzzled by a “Working Group” in Washington D.C. that existed of the likes of Alan Greenspan, Larry Summers and former Goldman alumni Robert Rubin and Timothy Geithner – Ms. Born eventually resigned office on June 1, 1999. The toxic assets to which Ms. Born’s warnings were targeted famously exploded in fall of 2008. Ms. Born, her ignored warnings now vindicated, nonetheless keeps professionally quiet on the topic, letting facts speak for themselves.

The History of a Debt Crisis

After losing re-election as Governor of New Jersey in 2009, Mr. Corzine set his sights on making his mark in the derivatives world again when he replaced former Chicago Board of Trade president Bernard Dan as CEO of MF Global on March 23, 2010. While his results at MF Global were similar to his re-election attempt, Mr. Corzine made a different choice in the derivatives markets this time around. Instead of non-transparent off-exchange mortgage derivatives, Mr. Corzine chose the regulated derivatives industry when he took the reins at an FCM that had deep historic roots tracing its roots dating back to 1783 when English commodity trader James Man founded the firm. Little did anyone know at the time MF Global, long considered an industry icon of sorts, was now on a path to being sold off in bits and pieces in a fire sale to the highest bidder.

Upon taking control at MF Global, Mr. Corzine had two choices: he could gamble, rolling the dice on a heavy concentration to Sovereign debt, or he could have chosen the path of popularizing a defensive investment portfolio that includes a diversity of returns streams – a concept championed by a host of academic thinkers and investment practitioners. Mr. Corzine’s choice speaks to a lost opportunity at this moment in economic history.

In choosing to gamble with Sovereign debt assets over focus on integrating uncorrelated investments into traditional stock and bond portfolios, Mr. Corzine wasn’t looking to the future, which is unfortunate. Upon taking over MF Global, he quickly stated his long term vision was one of logical asset management, transforming the FCM into the next big thing on Wall Street. This gave those in the managed futures industry reason to cheer. In the end, however, he couldn’t overcome his past where significant risks were taken – some that worked, some that didn’t. The difference between Goldman Sachs and Corzine’s MF Global is that Goldman often takes the both sides of trades – as they did in the mortgage derivatives crisis. At least they embrace the concept of diversification of risk and returns streams. Mr. Corzine’s concentration concept just didn’t work out.

“You shouldn’t risk more than you can lose,” noted veteran industry observer John Lothian. “This goes for traders as well as brokerage firms.”

What’s interesting here, the overlooked component is that Mr. Corzine gambled from within the futures industry which is known for “gambling.” However, the opportunity Mr. Corzine missed is the industry is really based on risk management and hedging, not raw speculation. The growing futures industry movement is away from raw gun-slinging speculation, to embracing logical asset management with an investment generally uncorrelated to the stock market through managed futures. It is an industry increasingly looking like an insurance company with probability tables and less like that represented by the Wild West and a gun slinger attitude of investment concentration. Unfortunately Mr. Corzine chose making his highly concentrated leveraged bets in Sovereign debt markets rather than expanding the concept of uncorrelated investments.

It’s in the uncorrelated investing concept that many on Wall Street seem to have problems. Perhaps it was the message about an investment that operates independent of economic strength that just didn’t jive with Mr. Corzine? Or it could have been the industry concept of account segregation and transparency where he might have missed the derivatives management memo? Clearly the defensive concept of true diversification didn’t resonate.

There is a movement in the futures and options industry away from the cowboy speculator and towards a logical and risk-focused investment. This is the direction many had hoped Mr. Corzine would take MF Global, the brokerage firm once considered industry legend. But that, apparently, isn’t going to happen.

As Mr. Corzine and Company are managing their margin call, liquidity drying up all around them, the opportunity to expand the concept of diversification with investments uncorrelated to the performance of the stock market might have received a temporary set-back. However, as a looming US government debt crisis that won’t go away easily becomes better understood by those including Mr. Corzine, the concept of true asset diversification is something that should not be ignored at this moment in economic history.

Mark H. Melin is currently writing his fourth book on uncorrelated investing.  He is previous author / editor of three books, including High Performance Managed Futures (Wiley, 2010) and an adjunct instructor in managed futures at Northwestern University.  He can be reached at markhmelin@yahoo.com

Contents of this article Copyright (C) 2011 Mark H. Melin.

Risk Disclosure: Managed futures can be a volatile investment and is not appropriate for all investors.  Past performance is not indicative of future results.

The opinions expressed in this article are those of the author, may not have considered all risk factors and may not be appropriate for all investors.

The Occupy Wall Street protesters and their sympathizers are catching a lot of grief from well, people who work on Wall Street, and from some members of the media friendly with those who work on Wall Street. They say the protests lack reasonable goals and there is no clear end-point. One might also surmise there is a sense of unease about having several hundred people who don’t like you and despise your line of work camped outside your office day-in and day-out.

And yet, it’s not just the camped-out protesters who sense things are amiss in the world of finance. Paul Brodsky of QB Asset Management told Barron’s the protesters are “credible,” and that they represent “a ‘disenfranchised majority that is quickly growing disenchanted’ with our financial system and its workings.”

Kynikos Associates’ Jim Chanos and PIMCO’s Bill Gross have said they understand the protests. Chanos told Bloomberg on Oct. 11, “People are angry, they feel the game is rigged and they didn’t get their fair shake.”

Citigroup’s Vikram Pandit called the protesters’ sentiments “completely understandable.”

And just today, Leon Cooperman of Omega Advisors without explicitly saying he supported Occupy Wall Street—who knows, maybe he doesn’t—leveled some of his own criticism of the markets. Cooperman said at the Value Investing Congress in Manhattan that high-frequency trading “has turned the market into a casino,” and that he supports the return of the uptick rule to do away with it, as well as limits on who can participate in the credit default swap markets and reining in speculation in exchange-traded funds. (more…)