* Berkeley Lab seeks early warning of future flash crashes
* Lab focuses on VPIN, HHI variant as key monitoring tools
* Lab research also precursor to consolidated audit trail
By Herbert Lash
NEW YORK, Nov 9 A system that could be used to
monitor the ultra-fast algorithmic trading that dominates Wall
Street is taking shape at the U.S. government's supercomputing
complex in Berkeley, California.
Scientists at Lawrence Berkeley National Laboratory (LBL)
believe a "yellow flag" alert akin to warnings used in auto
races would be better in preventing catastrophic market turmoil
like the flash crash of May 2010 than the circuit breakers now
The scientists examined two metrics they believe hold
promise for an early-warning system of unusual market
Their research also addresses desires for a "consolidated
audit trail" that regulators have urged since the flash crash
revealed the difficulty in monitoring high-frequency trading.
It took regulators almost five months to reconstruct what
happened in a span of minutes on May 6, 2010 because of
multiple marketplaces and diverse auditing systems. A single,
integrated record of all U.S. equity trading activity should
help regulators better understand and police markets.
Regulators should prevent disruptive incidents instead of
reacting to them like aviation investigators, said David
Leinweber, an expert in algorithmic trading who co-founded the
Center for Innovative Financial Technology at LBL.
"After the crash you get the flight data recorder and try
to figure out what happened," said Leinweber. "Let's manage the
congestion, manage the flow and understand when things may be
going wrong and try to avoid them."
The LBL study was prompted after discussions with Gregg
Berman, a senior Securities and Exchange Commission advisor who
was a lead investigator for the flash crash, Leinweber said.
The center was started in 2010 to bridge supercomputing and
financial markets, an area that has drawn little research.
"After the flash crash it became pretty clear that
understanding markets was more of a data-intensive science than
the federal regulators charged with understanding markets had
the resources to deal with," said Leinweber, a former portfolio
manager at quantitative hedge fund First Quadrant, where he
oversaw $6 billion in equity assets.
Regulators face issues tracking trade data, including
incompatible systems and inadequate computing power.
The requirements of a consolidated audit trail and who will
run it have not been decided. The Financial Industry Regulatory
Authority, a self regulator of U.S. brokers, has said its OATS
system for tracking trade information could be expanded to meet
the SEC's goals.
An LBL study found two indicators that exhibited early
warning properties preceding the flash crash: A variant of the
Herfindahl-Hirschman Index, a measure anti-trust authorities
use to determine competition in an industry, and a metric known
VPIN was developed by Marcos Lopez de Prado, head of
high-frequency futures trading at Tudor Investment Corp, and
Cornell University professors Maureen O'Hara and David Easley.
The metric anticipates market imbalances hours before the
flash crash and can identify short-term "toxicity-induced"
volatility, a research paper by the three said.
(Reporting by Herbert Lash; Editing by Andrew Hay)