How Robots Manipulate Natural Gas Prices

In the past few months, predatory high frequency trading (HFT) tactics have targeted natural gas so hard, that traditional traders are abandoning the trade entirely, says the Wall Street Journal.

And if that doesn’t concern you, for the rest of us this manipulation means the price of natural gas can fluctuate wildly.

Here’s how it all goes down:

Natural gas traders wait for a weekly national natural gas inventory report that’s released every Thursday at 10:30 a.m., and trade on the figures about supply and demand. Usually they put orders into the futures market based on what they think the information in the report will do to the price of natural gas — these are called resting orders.

For HFTs, the resting orders are actually sitting ducks, so they’ve started doing something called “banging the beehive.”

Now what is that? It means that HFTs send out a barrage offers to fill the orders right before the report comes out to push up the price of natural gas. They’re trying to get traders to send out more orders, which will then move the market. The result is extreme volatility, and HFTs love that.

Here’s what Eric Hunsader, an executive at market data firm Nanex told the WSJ:

The EIA reported an inventory increase of 25 billion cubic feet, slightly below analysts’ expectations, which normally would translate into a modest price rise. In the first seconds after the release, natural-gas futures surged more than 10 cents to $2.84, but then immediately ricocheted lower. The fastest traders had the chance to profit from rapid buying and selling over a much wider price range as the market slowly found some equilibrium, says Mr. Hunsader. Over the next seven minutes, futures dropped to a low of $2.685. Prices didn’t hit those highs or lows for the rest of the session.

It sounds crazy, so we reached out to a trader who blogs about these swings at website, Calibrated Confidence to see if it looks just as crazy.

Here’s what he wrote about an inventory report in April of this year:

Natural Gas inventory level change came in at 32% of what was expected and here’s what the computers did. Something to consider would be how far you are from the exchange. By the time this information got to you, it could very well be considered a stale price that is now, a near 200ms (milliseconds) later, all information. Pretty scary stuff we’re allowing into the deep infrastructure of our markets…

In short, all of this happens in a flash. If you’re not using HFT technology (combined with a nice location near an exchange) it wil hit before you can make a move.

And here are the charts that show you whats up.

You can see at 10:30:00 the depth of bids (natural gas orders) on the book exploded from a few hundred to over 2,000 contracts.

natural gas orders

With that kind of momentum, HFTs can swing the market, and it doesn’t matter what’s in the report because they’re not trading on information. They just like that so many traders are out in the open — it’s kind of a feeding frenzy.

From the WSJ:

“It was always going to be volatile, but at least if you had the right idea, you’d get paid for it,” said Scott Gettleman, a Nymex floor trader. “Now, you can put yourself on the line, but you’re flying blind.”

Who wants to do that?

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