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High Speed Trading? Ho Hum.

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July 27, 2009 – Comments (27)

This probably isn't new news to many of you, but I was reading an article today entitled Stock Traders Find Speed Pays, in Milliseconds that talked about the fact that some of the 'supercomputers' that some of the 'big guys' use might be giving them an unfair advantage in stock trades, allow them to possibly manipulate stock prices, and reap huge profits.

I'll admit, one part of the article made me gnash my teeth:

The slower traders began issuing buy orders. But rather than being shown to all potential sellers at the same time, some of those orders were most likely routed to a collection of high-frequency traders for just 30 milliseconds -- 0.03 seconds -- in what are known as flash orders. While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee.

That's a loophole that in this Fool's opinion should be closed.

Why then do I say 'Ho Hum'?

The result is that the slower-moving investors paid $1.4 million for about 56,000 shares, or $7,800 more than if they had been able to move as quickly as the high-frequency traders.

Thats about 0.6%.  Considering that I invest in stocks to meet long-term financial goals and generally hold my stocks a long time, I'm not personally terribly concerned about this increased 'cost'.  Make no mistake, what's fair is fair, and if an order is supposed to be shown to everyone simultaneously (as it should be in a completely free, open, and fair market) then it should be.  Being able to pay a fee and get information on stock prices and offers not available to the other market particpants is just plain wrong.

But this Fool isn't going to lose any sleep over it.

Regards,

Russell (a.k.a. TMFEldrehad)

27 Comments – Post Your Own

#1) On July 27, 2009 at 1:40 PM, anticitrade (99.65) wrote:

I thought the same thing when I read the article.  I think people have over reacted to the use of super computers in stock picking.  I also like to think of myself as a buy and hold investor, in which case, I don't believe I am competing with these systems at all.  It's probable that the majority of their gains are made on correcting small market inefficiencies... 

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#2) On July 27, 2009 at 2:00 PM, alstry (36.03) wrote:

You are not losing sleep, because you have no idea what you are talking about.

If you understand the mathematics behind the upward bias by locking markets are the margin with algos trading between algos, you might be a little more concerned.  When you are over 70% of the trading, you effectively become the market.

If four or five fraudulent transations occur in a housing neighborhood, you set the comps based on those four or five transactions.  If innocent buyers use those comps and pay much higher prices because of the fraud, you now have collateral damage....now mulitply that across the nation and you have a serious problem...especially if it is leveraged by more debt than exists in savings.

The front running is only the beginning, it is the ability to manipulate by locking a market at the margin that will shock the nation when we finally wake up and understand how bad things are fundementally.

But who is Alstry to wake you up from your good nights sleep?

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#3) On July 27, 2009 at 2:13 PM, anticitrade (99.65) wrote:

Alstry, I must be in real trouble because I can't even understand your sentence:

If you understand the mathematics behind the upward bias by locking markets are the margin with algos trading between algos, you might be a little more concerned.

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#4) On July 27, 2009 at 2:21 PM, alstry (36.03) wrote:

I don't proof read as much as I should....;)

should read:

If you understand the mathematics behind the upward bias by locking markets AT the margin with algos trading between algos, you might be a little more concerned.

Basically if a  bunch of computers start arbitrarily buying and selling back and forth to each other at a set price, that price becomes the market regardless of the fundementals.  Mutual funds must buy regardless of price so an upward bias is created in the stock.  Since high frequency trading is market wide, that upward bias extends market wide regardless of fundementals.

It is basically a mechanism that manipulates markets regardless of fundementals....in part, that is why improper churning is illegal....it creates the illusion of liquidity at a set price when in reality none exists.

Just like the analogy with housing....if it applies to a specific neighborhood, that is one thing.....if the fraud is nationwide, something very different.

The churning going on with HFT is market wide.  Watch out, this will make Watergate look like a petty misdemeanor.

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#5) On July 27, 2009 at 2:26 PM, Imperial1964 (98.28) wrote:

I recognize it isn't a lot of money, but for me it is a matter of principle.  If the allegations are true, do you believe these guys should be able to "peek" at the limit of your limit orders?  I do not believe so.

Front-running is already illegal and if the SEC sets the precedent that market makers are immune from investigation I will become concerned.  I've seen enough fraud and conflicts of interest go without investigation lately.

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#6) On July 27, 2009 at 2:30 PM, bigpeach (27.16) wrote:

Alstry,

While your scenario is theoretically possible, there is no evidence that such collusion between investment houses actually occurs.

I too don't care about this. Such trading may make me pay fractions of a percent more than I would have were they absent, but they will never force me to pay more than I want to. This is really nothing new anyway. Brokerages with sophisticated trading platforms have always been faster than ordinary investors. Even before computers.

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#7) On July 27, 2009 at 2:31 PM, alstry (36.03) wrote:

Last year, HF Traders made $21 Billion dollars.....$21 Billion dollars just between a few firms.

But the real money was made in the price manipulation of stocks....that number will really never be known.

There is a reason why improper churning and front running are illegal, combine the two on a marketwide basis, and you have the mother of all scandles.

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#8) On July 27, 2009 at 2:47 PM, SolarisKing (< 20) wrote:

If it was only 0.6% i wouldn't be worried either, but i think what happens is they then keep the stock from dropping, and then on the next bounce get another 0.6%. They know that folks have stops, so by creating a certain amount of swing volatility they close a persons stops, and give themselves a chance to buy more at a lower price. Then drop the price again, and sucker the same folk into buying again, just to get stopped out again

The price of the stock goes up, and up, and up, and a zillion fools lose, and lose, and lose. Until the are closed on their shorts, and lose a lot more.

Then when it looks right (unsustainable) they do the same thing in reverse. 1% on the way down, and 1% down, and 1% down. Then they send it so deep that MANY PEOPLE will panic and or sell, and or get stopped out, and when they do, the robot reverses and goes up again.

I am glad that you have enough money and experience to know what to do, and weather the storm, but i feel for others, who think that things are fair when their not.

It's a heck of a way to stabilze the public economy (not). Even if YOU weather the storm, if such a scheme destroys the savings of a large portion of average american investors, then they are not going to be buying the products from the companies you own stock in.

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#9) On July 27, 2009 at 2:53 PM, SolarisKing (< 20) wrote:

#6) On July 27, 2009 at 2:30 PM, bigpeach (95.39) wrote:

Alstry,

While your scenario is theoretically possible, there is no evidence that such collusion between investment houses actually occurs.

 

I guess it's only a conspiracy if you say "I won't say anything if you don't say anything". If one just winks, and you wink back, then technically it's not a conspiracy.

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#10) On July 27, 2009 at 3:04 PM, anticitrade (99.65) wrote:

Solaris,

You talk about the average investor having stop loss and limit orders out in the market, they don't.  The average investor has their money sitting in a 401k or mutual fund and rides these waves up and down.  I can accept that the average active investor who makes short term gambles will lose against these systems.  BUT if these systems create market prices that deviate from reality they are implicitly creating opportunities to profit.  That's my theory anyway.

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#11) On July 27, 2009 at 3:25 PM, bigpeach (27.16) wrote:

I guess it's only a conspiracy if you say "I won't say anything if you don't say anything". If one just winks, and you wink back, then technically it's not a conspiracy.

Well, yes, you're right that would not be a conspiracy, but morally wrong. My statement however remains. There is no evidence that this is occuring. People on this site seem to have forgotten that one is presumed innocent until proven guilty. Theories of wide spread collusion to manipulate stock prices, while popular on this site, are (at this point) baseless.

If you believe HFTs have a trading advantage against you, then don't trade against them. Try investing. No price speculation, no stops. That was the point Eldrehad was making anyway. HFTs have no advantage over investors.

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#12) On July 27, 2009 at 3:39 PM, alstry (36.03) wrote:

First,

When you are 70% of market volume....you effective are the market.

Second,

Conspiracy theory need not enter the equation.  When a large pecentage of market participants, namely long only mutual funds, must stay fully invested, they must be, in the aggregate, buyers of shares.

If you can control 70% of the volume at the margin trading, simply by creating the illusion of liquidity masked by volume, you force mutual funds to pay inefficient prices.  Taken that across all market participants you create an inefficient market as most pay manipulated prices.

This is why churning is illegal and by definition, HFT is effectively churning.

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#13) On July 27, 2009 at 3:41 PM, StopLaughing (< 20) wrote:

If I understand Alstry's argument right, he is saying that since the flash trading is 70 % of the market they are market makers who can manipulate the  market up or down depending on which way they want the market to go.

GS can take a short or long position in key volitile high beta stocks and then use the flash trading to move the whole market up or down. They would make little money on the flash trades but own a mint by trading the high betas.

This would be very easy if they also had inside information on the timing and direction of market news.

The flash trading is a real menace to the integrity of the market. It makes a difference to buy and hold types as it changes the patterns in the market prices.  Technical analysis may not work quite the way it used to. 

I have maintained the this current market acts much more like a derivative market than the stock market of the last 50-10 years.

The Flash trading is an added tool to the stock manpulations caused by the options, commodities and credit swap transactions. The cross elasticities with the derivatives make the stock market to act like a derivatives market. 

Much of that action is in the shadow banking system or off shore in a non US exchange.

The market has to be fair or people will refuse to trade. The big "financials" have owned both parties. That has tilted the playing field in subtle ways. There has to be regulation to insure a level playing field. 

The big financials have been able to stop any attemp to regulate them effectively. 

 

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#14) On July 27, 2009 at 3:47 PM, alstry (36.03) wrote:

Third,

If investors are paying high prices for investments that are effectively worthless, only because high frequency traders are creating the illusion of liquidity at a certain price level drawing in investors, even if you have a long term outlook, you are hosed once the HFT back off and the price reverts to an efficient level.

This is happening everyday.....homebuilders are an excellent example.

Most have some cash in the bank, some multiple of debt more than cash, and are losing money quarter after quarter.  A company that loses money in its operations and has much more debt than cash and assets is effectively not worth very much, if anything....but the market is valuing them at hundreds of millions of dollars as computers trade millions of shares back and forth to each other at rediculous price levels.

At some point, the computers will back off and the investors as a group will get killed........never knowing what happened to them until its too late.

 

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#15) On July 27, 2009 at 3:51 PM, StopLaughing (< 20) wrote:

At 70 % of the market the flash traders can create short term momentum which would create a short run self fullfilling prophecy. There would be enough whip in the high beta stocks to create substantial profit given the very small transaction costs the flash traders experience.

It may not seem like much but in a casino the house always wins in the long run and all of the rest of the players lose by the house take. 

The Flash Players become the house as the exchange sold them the rights to the house.  That raises the exchange cost for every non flash trader. It is a hidden cost but a substantial transaction cost over time.

In plain language this is a rip off, a sophisticated type of price fixing by collusion between the exchanges and the flash traders.

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#16) On July 27, 2009 at 4:05 PM, StopLaughing (< 20) wrote:

The flash trading is just one more tool that can be used to transfere the wealth from the 401 Ks to the shadow banking system.

The 401 Ks have regulatory biases built into them that prevent pretty much everything except a buy and hold strategy with in a limited set of mutual funds. As the money comes in every month the funds feel pressure to buy. 

The Flash trading transferes part of the 401 K wealth to the shadow bankers. The 401 Ks are a flock of sheep who are constantly being shorn. When the time is right the shadow bankers will spring another collapse like last fall. That will transfere about 1/2 of the money in the 401 Ks to the shadow bankers who will be short the market and creating the collapse. 

Alstry is unfortunately right. There will be another collapse but it will be later after the majority thinks the market and economy have recovered. 

Right now the majority of small investors are bearish and many are putting thier money into MM funds instead of stocks. That money has to move to stocks before the next collapse. 

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#17) On July 27, 2009 at 4:07 PM, StopLaughing (< 20) wrote:

The flash trading is just one more tool that can be used to transfere the wealth from the 401 Ks to the shadow banking system.

The 401 Ks have regulatory biases built into them that prevent pretty much everything except a buy and hold strategy with in a limited set of mutual funds. As the money comes in every month the funds feel pressure to buy. 

The Flash trading transferes part of the 401 K wealth to the shadow bankers. The 401 Ks are a flock of sheep who are constantly being shorn. When the time is right the shadow bankers will spring another collapse like last fall. That will transfere about 1/2 of the money in the 401 Ks to the shadow bankers who will be short the market and creating the collapse. 

Alstry is unfortunately right. There will be another collapse but it will be later after the majority thinks the market and economy have recovered. 

Right now the majority of small investors are bearish and many are putting thier money into MM funds instead of stocks. That money has to move to stocks before the next collapse. 

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#18) On July 27, 2009 at 4:26 PM, bigpeach (27.16) wrote:

I repeat:

If you believe HFTs have a trading advantage against you, then don't trade against them. Try investing.

You have missed Eldrehad's argument with your talk of trading. The point he made (I agree with it) is that while HFT is a bit unfair, it's not a big deal if you're a long term investor.

Investing creates wealth over time. Price speculation is a zero sum game. If you want to speculate, better speculators will beat you.

Alstry, I would challenge you to produce some evidence beyond your usual 'it could theoretically happen' argument

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#19) On July 27, 2009 at 5:01 PM, alstry (36.03) wrote:

You miss the point...TMF Elderhead has no argument to begin with....

If an investment is essentially worthless.....like present day homebuilders.....it doesn't matter how long term your investment perspective is.....at some point the investment goes to zero.....despite the fact that HF Traders and mutual funds are buying it in the process.

When the integrity of the market is undermined at its core, and such behavior is permitted by those that are supposed to police it....pretty soon there is no market for anyone.

That is the point.....and the only point.

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#20) On July 27, 2009 at 5:17 PM, SolarisKing (< 20) wrote:

antic, they would create opportunities for profit, except the machine is designed to switch directions when you are about to make a profit.

Yes, i know that there are a few professionals (by the way, i really respect your work here) who can spend alot of time keeping up with the game. But, being unfair to someone is unfair. These bankers already have nepotism on their side, and all the insider knowledge that goes with it.

How many advantages do they need?

Respectfully, sir. Your point is akin to saying it's ok to shoot me, as long as you don't kill me (most of the time), because it should teach me to watch where you point your gun, and then claim that there is no place your not aloud to point it. 

Personally i would rather fight fair, then just jump on the badwagon with the next sinner/thief/banker/dictator/ponzi. 

This sort of unregulated good ol' boy backroom behaviour is the same morallity that caused the financial collapse. It is entirely possible that this depression will last for decades. If someone bought into the market right before this scam collapsed (like i did) they might not see a real profit for their entire lives.

I mean really. How long do you think it will be before the market gets (and stays) 20% above it's highs? and even then, unless a folk was a trained financial professional, what are the chances that his accuracy was above 50%?

So i might have to wait 20-30 years before i make 10%?

Let me tell you about how i got burned last year in gold (i think it was gold, sorry). I had a futures put, and when the market collapsed folks started to buy gold. There is supposed to be a lime on how far that future can go in one day (to slow down panics). I go to work, and when i come home the future has moved TWICE it's legal limit of ticks.
   THE FEDS HAD JUST REMOVED THE LIMIT. Just removed it, while i was at work. Everyone who is a professional was just alerted by their secretary, and had the chance to get out. EVERYONE WHO HAS A JOB just got taken to the cleaners.

THEY CHANGED THE LAW, WITHOUT NOTICE, FOR ONE DAY ONLY, IN THE MIDDLE OF THE DAY! ! !  DAMN RIGHT, I'M MAD !!

 This question isn't just about potential profit, it's about morallity, and it's hard to make decisions if they change the rules while your at work, or if they don't have the same rules you do.

I hope you understand what i'm trying to say is not directed at you, or TMFElderhead. 

It wouldn't be so insulting if these weren't the SAME GUYS that just got away with all this other stuff.

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#21) On July 27, 2009 at 5:45 PM, anticitrade (99.65) wrote:

Solaris,

I agree with most of what you say.  When I first started investing I lost $84,000 in 2 weeks which was 42% of my original $200,000 investment (it was my universities money, so the pain was mostly ego and guilt).  I had done my research, I had picked good stocks, and I could give you 10 good reasons why each of them were undervalued.  But as a consequence to some of the things you mentioned, I lost big time (things turned out great after a few more months). 

I think we have to accept that markets are manipulated, investing is not fair, and the average investor is mostly disadvantaged.  I am not a revolutionary, so I try to focus on how to win despite these rules.  Just like small mom and pop shops have advantages that large retail does not, small individual investors DO HAVE some advantages that institutional investors do not. 

I think these are:

Time horizon (we can focus on the long term, where companies must focus on quarterly results)

Small cap (large buyers can not handle the transaction costs of small volume companies)

Lack of Apathy (large companies are filled with people who may or may not care about the profitability of the company, some of these people are dead weight and others take unreasonable risks to make short term returns)

There may be others. Its not much, but if I didn't believe these things existed I wouldn't even try.  Good luck!

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#22) On July 27, 2009 at 5:56 PM, Nainara (< 20) wrote:

Computers introducing inefficiencies and mispricing into the market?

I can hardly imagine a greater stroke of fortune. My worst nightmare investing scenario is an equity market in which every issue is priced rationally...

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#23) On July 27, 2009 at 6:06 PM, alstry (36.03) wrote:

Irrational behavior is fine....any of us who have been married for any length of time can attest to that.....

But when few control the irrational behavior and dictate the outcome on demand, you take a rationally irrational environment and replace it with a manic depressive nut job.

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#24) On July 27, 2009 at 6:13 PM, SuperCharge (88.14) wrote:

You miss the point...TMF Elderhead has no argument to begin with....

Understood, your point is that wealth in general as we know it will soon be worthless come 09.09. Maybe you're right, but Eldrehad still has a point.

That an investor is willing to pay $19.30+ for TOL today means that he/she finds current & potential future value in the company and therefore it isn't essentially worthless until the day it trades at $0. 

Trading at $19.30, HFT's can pay on average $0.11, or .6% less than you or me per share of TOL. If I understand correctly, they would then be able to sell the stock at another .6% price difference.

Especially if you're a big money long term investor, that .6%-1.2% can really add up over a long period of time. Although it won't make me lose sleep or huge sums of money, the principle absolutely ticks me off.     

 

 

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#25) On July 27, 2009 at 6:28 PM, alstry (36.03) wrote:

Over 90% of the average mom and pop investor dollars come through mutual funds.  Much of that is in the form of index funds and managed mutual funds.

A number of my neighbors and acquaintances are mutual fund managers.  They don't have a choice, they must buy regardless of the price....especially if they are playing against an index.

If most of the nation is paying excessively high prices for their investments due to manipulation, they will be screwed out of a huge percentage of their savings once things revert to normal, plain and simple.

The individual "value" investor is such a small segment of trading, the impact on the market is practically nil.

Again, the issue is not the nickel or a dime front running and adding up to tens of billons of profits per year.....it is the creation of an artificially overvalued by churning market for an extended period of time that can wipe out the savings of long term investors....FOREVER.

Just ask anyone who has purchased a home in the last four years.

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#26) On July 31, 2009 at 2:17 AM, alexxlea (52.68) wrote:

The fact of the matter is that market makers pressure the market to the upside and the downside to maximize the amount of stops and limits hit at unreasonable numbers. Too many people are momentum chasers and this only adds fuel to the fire. Watching price action I see that the last bids change so frequently that it's often quite obvious that something is just plain wrong with the action. In my opinion quant trading helps me a great deal towards my goal of daily profitability because if it is true that they distort orders to the up and downsides and they are the market then they are just trying to get people to buy higher and sell lower, meaning intraday inclines and declines will be much sharper. Today's morning action was just one example of the great profit-making opportunities that computerized trading brings us. Shares were bid up so fast that I doubt that everyone in the world is awake at 6:30 ready to chase momentum. It's more likely that limits on the top side were spotted, and the market was pushed high enough to hit those upper echelons. That way people were sold stocks in the greatest quantity above the soon to be lowered price points later in the day, and people's stops started to get hit.

 The modern stock market is just the banks and the institutions, and as has been stated it's not hard to see who has the edge there. Myself, I am trying to make a (not lifelong, but perhaps multi-year long) career out of this sort of stuff so it doesn't worry me that it's going on, because it can be profited from. My main concern is that the majority of trading has become, as you put it, speculation. The equities market is currently in full tilt, and you can see by the amount of margin people are taking out that they are betting heavily on this current run, which I think will be devastating to people's accounts if they do not watch them carefully.

 And it's true that if you nickel and dime someone who has a hundred dollars enough times, then that person will be left with nothing in the end. So you might not care that your shares are bid up at an increasing rate, or that they are being bid down, but you must realize that in the long run this certainly does affect you as a "long run" investor. And doesn't it unsettle you even a bit that you are not going to be trading with other humans, but rather have to deal with the bank as a middle man who will determine the current market price, forcing you to adjust your entry and exit prices and who also watches your every order entry?

Separate the banks. Tear them apart. Regulate them. Don't allow them to self-regulate. Have me oversee them. Disallow private donations to government. Get the politicians of this nation out of the pockets of the ones they are supposed to be going after. Don't allow investment banks to take government aid. Don't allow financial institutions to speculate. Don't allow the oil futures market to continue operating in its current form. Stop speculation of food as a traded commodity. The list goes on. There's too many problems to fix and no one willing to even start on the list.

I'll stop my rant. Made money today but money for myself is useless until I can get enough of it to help. Money is power and power corrupts and I pray to God I have the strength to stay sane and righteous even when I have a lot of these dollar things people seem to want so much.

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#27) On August 04, 2009 at 11:35 PM, FleaBagger (28.69) wrote:

I skipped a lot of comments, so this may have already been addressed, but I feel it needs to be said. You who have the cavalier attitude about front-running at large investment banks must not know anyone who invests in mutual funds. Oh, you do? Well, you must not care about those people, because they're losing their shirts to this scam. Mutual funds are among those traders constantly putting in limit and stop-loss orders, and getting gamed by GS and JPM, and the other criminals running our country. They do this with enormous leverage provided interest-free by the Fed, whose access to this "capital" is derived from inflating away the value of the savings of the benighted lower castes.

Have you ever wondered why mutual funds underperform the S&P and inflation? Well, the people who own them don't. And the whole financial services industry is counting on that continuing.

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