High-speed commodities traders under scrutiny
- High-speed commodities traders under scrutiny
By Gregory Meyer in New York
Just over a week ago, Avery Putter, a commodities broker with Spectron, was preparing to buy cocoa options on the floor of New York's ICE Futures US exchange. As he glanced at the futures price, it suddenly plummeted. In less than a minute, the cocoa contract had fallen 12.5 per cent.
"Stuff like that happens all the time," Mr Putter says disapprovingly. "It's the norm these days."
The fall in cocoa, which rebounded within minutes, is the latest example of the extreme volatility that has rippled across "soft" commodities markets including cotton, sugar and cocoa, leading to strong protests to ICE officials.
Many people blame the rise of so-called high-frequency trading firms, which use computer algorithms to seek out pricing and other discrepancies in markets and trade in millionths of seconds.
IntercontinentalExchange, which bought the old New York Board of Trade in 2007, replaced open-outcry futures trading with computer screens three years ago. Its electronic futures markets have experienced sharp price swings. The raw sugar futures contract, a global benchmark, dropped 6 per cent in a single second on February 3. Trading in ICE cotton futures has been halted in 14 of the past 15 sessions after prices reached exchange-imposed daily movement limits.
"We have seen this thing go from functioning to a crapshoot," Jordan Lea, president of the American Cotton Shippers Association, a merchants' group, says of the futures market.
ICE's switch to electronics enticed computerised traders into commodities. Some of these traders buy and sell with a computer mouse, while others such as Chicago-based Infinium Capital Management and DRW Trading also use algorithms to trade at blistering speeds.
The exchange and analysts, though, dispute suggestions that high-frequency traders are responsible for the price swings. They say such traders have a smaller presence in soft commodities than in other futures. The real cause of the volatility lies elsewhere, they believe.
The high-frequency traders argue that they reduce volatility, not increase it. Chuck Whitman, chief executive of Infinium, said in a speech last month that electronic trading would be "exciting" for the agriculture industry, stabilising its profit margins.
"This stability will help serve the greater good by helping to dampen volatility in food prices, and helping to keep overall food prices lower," he said.
Thomas Farley, president of ICE Futures US, says high-frequency firms make up "less than 10 per cent of our overall volume" in softs markets. Tabb Group, a consultant, estimates that proprietary trading firms generated 45 per cent of overall futures markets volume last year.
Mr Farley says: "If there is a notion that volatility in the softs markets is heightened due to the presence of high-frequency traders, that notion is wrong. I submit that the opposite may well be true: if we had greater participation from that class of trader, the volatility could in fact be lessened."
The Commodity Futures Trading Commission is looking into last week's decline in cocoa. Traders, meanwhile, have pointed to a large sell order, which in turn triggered "stops", or automatic orders to sell, driving the market lower, an account that has drawn comparisons with the Wall Street "flash crash" last May. A government advisory committee studying that crash, in which the Dow fell hundreds of points before rebounding, said that electronic trading had cut transaction costs but made markets fragile at times of high volatility.
Whether or not high-frequency traders are to blame, the supply-demand balance may be a factor. The sharp price swings also come amid a severe scarcity of some important crops, making markets highly sensitive to news of supply and demand.
Last year's cotton crop is virtually sold out and a political standoff threatens cocoa supplies from Ivory Coast, the largest exporter. Mr Farley says low inventories, high prices and greater geopolitical risk have increased volatility. But electronic trading may have accelerated it. Jim Cassidy, at futures broker Newedge, says: "High volatility is partly a function of high prices. But the flashes -- the abrupt, frenetic, substantial price moves that occur in seconds or minutes -- that's a new?phenomenon I think is significantly related to electronic trading."
