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February 1, 2013

FINRA Steps Up Surveillance

By Tom Steinert-Threlkeld

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  • FINRA Steps Up Surveillance
  • Page 2

The Financial Industry Regulatory Authority has begun to implement a new set of computer programs that watch for illicit trading patterns across national exchanges, dark pools and brokers' internal pools of orders, as well as alternative trading systems.

FINRA is broadening its surveillance in two ways: the number of markets it can and will watch at the same time, with each pattern; and its ability to watch multiple trading firms, at the same time, that may be acting in concert.

In effect, the independent regulator of brokers can now keep track of the actions of multiple parties working across multiple markets at the same time.

FINRA says it will use rigorously tested programs to watch for patterns of behavior across markets and trading firms-patterns that indicate questionable activity is taking place.

Tom Gira

"We have introduced a suite of cross-market surveillance patterns that canvasses the 80 percent of the listed equity markets that FINRA regulates in a holistic way, which includes trades internalized at broker dealers, alternative trading systems and dark pools," said Thomas Gira, executive vice president and head of market regulation at FINRA. "Across the board, we are going to be looking for questionable conduct. Some of that could be in dark pools. Some of that could be on exchanges."

In effect, where FINRA had multiple, similar patterns looking for the same conduct on different markets, it will now be able to use a single program to look for a given pattern across all markets, he said.

The surveillance will cover 1 billion order events being generated daily by venues that include exchanges operated by Nasdaq OMX Group and NYSE Euronext, as well as the dark pools, broker's internal pools and alternative trading systems that make up the over-the-counter equities markets, Gira said. Exchanges operated by BATS Global Markets and Direct Edge are not under FINRA's watch and won't be part of the surveillance.

"The bad news is, 20 percent of the market is missing," said Howard Tai, senior analyst at industry consulting firm Aite Group. "The good news is, 80 percent is there."

BATS and Direct Edge operate all-electronic exchanges that largely cater to algorithmically driven customers, using complex, high-speed trading strategies.

See Sidebar: What FINRA Is Looking For

"They might have a higher success ratio, if you could include those two," said Howard Tai. Nonetheless, he said, "it's a start. It's the right start."

Among the patterns FINRA will be looking for are matched orders to buy and sell shares of a stock that create the false appearance of market activity, generally called "wash sales," as well as "momentum ignition" strategies such as layering, spoofing and marking the close.

"We are looking for abusive strategies where people, or more accurately computers programmed by people, are trying to ignite momentum in the marketplace to take advantage of that ignition," Gira said.