Chaos Theory

August 1, 2012 § Leave a comment

What happens when a butterfly flaps its wings in the rainforest? Can the beating of a tiny bee cause hurricanes over the Phillipines? Is a rainbow in Saigon the beginning of a revolution in Tibet?

Chaos theory. The interconnection of the tiniest molecules of human life with seismic events.

Yesterday the market looked into the void.

It started with a blip in the Japanese Nikkei index. At 6.45am GMT there was a surge of buying interest in the Nikkei 2014 futures contract. Traders saw nearly 200 times the market average transacted in a single minute. The vol receded almost instantly. A few minutes later, however, the Dax future spiked 16%. A concurrent drop occurred in the Yen/Dollar pair. Within 5 seconds the market had plunged 24% and then immediately righted itself. It happened in a matter of milliseconds. Too quick to realise.

But shocked traders with electronic execution models noticed. A few moments later the itraxx was hit sideways with 87bps  spread move.

It was a mafia hit. Like the film Godfather III, one by one all the main indexes were getting whacked. Someone was taking seismic positions to smash the biggest hedge funds out of the water.

Eventually a consortium held a conf call. No one knew who was doing this but market makers decided to suspend trading for a few hours. Equilibrium was restored and we all went home to drown in a puddle of excrement.

This random event is beyond the pale. I have never seen that kind of volatility. People are shaking their heads wondering what happened. But look closer. Was it random?

A few months ago Molton Capital LLC issued a research note which was authored by an external analyst. It was a brief aside.  It stated a new market theory based on deep correlation analysis: research into electronic trading has discovered anomalies in the structure of the financial system. Big black inexplicable holes. The note posited a scenario whereby a large rapacious player may seek to move markets simultaneously leading to cataclysmic domino effect in other assets and classes.

Molton Capital is known to be one of the largest players in the dollar/yen electronic market and was naturally interested in this research. It is of course too small to manipulate markets but pointed out the dangerous conclusion of this theory. The rest of the world didn’t notice. But they should. We have a monster out there.

…….And who was the author of this note? Dorien Fassbender.

Chaos theory : the death of an analyst destroys markets across the world.

Addendum: The mainstream has noted some of the effects of this on NYSE stocks. It was blamed on Knight. What?


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