Posted on 04/07/2014 6:58:39 AM PDT by SeekAndFind
Government shouldn’t rush to judgment on Wall Street’s high-speed traders. Granted, this whole business probably looks dodgy to Main Street’s 401(k) owners and stock pickers. Financial brainiacs are employing sophisticated computer programs called algorithmic robots to quickly scan financial data streams for subtle stock-market patterns. Trading, and lots of it, happens in a flash. The algobots see what big institutional investors are doing while they’re doing it. Every millisecond counts, which is why traders pay hundreds of millions of dollars a year to rent space for their computers in stock-exchange data centers. Half of daily U.S. trading volume is now of the superspeed variety, much of it passing through dedicated, specially built fiber-optic lines and microwave transmitters.
What in the name of Warren Buffett does any of this have to do with stock markets as places that enable public companies to raise money and let the little guy put his savings to work? Very little, according to critics who argue that high-frequency trading hurts small investors and poses systemic risk to the U.S. financial system as seen in the 2010 “Flash Crash.” The Justice Department, FBI, and New York attorney general are investigating whether markets are being manipulated and unfair advantage given to high-frequency traders. Author Michael Lewis is out with a much-hyped and highly critical book on the practice, Flash Boys, in which he claims the stock market is a rigged game. Congressional Democrats can almost certainly be expected to renew efforts to tax high-frequency trading out of existence.
Here’s one way to think about the problem: Are high-frequency algobots an innovation more like automatic-teller machines or collateralized debt obligations? In 2009, former Federal Reserve chairman Paul Volcker called ATMs the “most important financial innovation that I have seen the past 20 years” due to their convenience. Volcker was less enthusiastic about more recent financial advances such as CDOs, an innovation at the heart of the financial crisis. So which kind of innovation is high-frequency trading? Is it something that makes the system work better for everyone? Or is it something that profits a few while creating huge risks for the public?
Certainly, combining clever software with superfast computers and telecommunications to make massive trades at light speed is, borrowing a phrase from Robert Oppenheimer, a “technically sweet” innovation. Also, the billions in profits made by high-frequency trading firms would suggest, at least to some fervent free marketeers, that this innovation has passed the “market test.” And there is no doubt that high-frequency trading has dramatically lowered trading costs and enabled faster order completion, which is especially helpful for small investors.
But the final cost-benefit analysis of superfast, high-volume trading can’t be determined by competing claims of participants, nor in the compelling, character-centered narratives of bestselling authors. As much as anyone, Moneyball author Lewis should understand that data — and lots of it — is a surer guide for action than flashy anecdotes. Regulators, lawmakers, and other officials must carefully examine the research on high-frequency trading. Unfortunately, too much is either industry-funded or conflicting. For instance: A recently released European study found that high-frequency trading increases volatility and makes flash crashes more likely. Those findings directly contradict a 2013 U.S. academic paper that found “scant evidence” of high-speed trading increasing volatility. For the moment at least, there seems little reason for hastily assembled legislation or quick-trigger legal action. We don’t want a high-frequency-trading version of Dodd-Frank, a rushed regulatory fix that few observers think has ended the “too big to fail” government backstop.
So gobs more data and analysis are needed. High-frequency trading would be a perfect subject for the Office of Financial Research, located in the Treasury Department. Without a clear consensus, however, government’s default position should be inaction. Regulators must not be guided by the “precautionary principle,” where government permits innovation only if it’s proven harmless in advance; the result is too often crony-capitalist favoritism of whatever incumbent firms have the best lobbyists. If nothing else, high-frequency trading is a disruptive innovation that certainly annoys many institutional investors who can longer covertly trade big orders without the algobots taking notice — an intramural Wall Street battle that is so far benefiting Main Street.
Government should also keep an eye on market action. Whatever impact, good or ill, high-frequency trading is having, it is likely on the decline. According to a Rosenblatt Securities estimate, high-frequency trading used to account for some two-thirds of U.S. equity action. And industry profits from stock trading are down by 80 percent over the same span. Still, if the consensus research does eventually make a compelling case against high-frequency trading, even the most ardent libertarians or tea partiers should demand government action.
Thanks to automation and globalization, it is more important that workers today and tomorrow also be capitalists and earn capital income as well as labor income. Both the 0.1 percent and 99.9 percent need to participate in a stock market they can trust.
— James Pethokoukis, a columnist, blogs for the American Enterprise Institute.
I refuse to invest in a market that can wipe me out in seconds.
The stock markets are now fully corrupted.
Are you saying HFT should be totally banned?
Just beating the bracket, perhaps by nanoseconds, and piggybacking on price movements in large stock purchases.
Maybe if the size of sales/trades/exchanges were limited, would this make the High-Frequency trading less attractive?
These automated trading algorithms have already vastly distorted the function of the market, and injected fluidity into transactions in such quantity that the trading of stock is even more mercurial than it has ever been. If this High-Frequency trading throws an element of caution into the big players, then it shall have done its job.
You’ve heard of pump&dump? Artificially raising the price of a stock you own and then selling it before the market realizes it’s horribly overvalued, booking profit while you laugh your way to retirement?
The opposite strategy works as well. If you can capitalize a significant portion of trading volume, you can short an equity until it sinks well below its real market value, and pick up a good stock for pennies on the dollar. You get to harvest stop-loss orders along the way too. After a few hours or a few days the price rises back to its real value and you can slowly sell off the bargains you picked up and book a nice profit.
It’s even easier to short a good stock into temporary penny-stock status if every other large trading firm out there is using automated algorithms to do the same thing you’re trying to do. A few good shorts and the automated sharks start a feeding frenzy that temporarily drives the price down like a fat kid doing a cannonball onto a trampoline.
From thence we get the flash crash - automated high-volume traders saw a good short-selling of some futures and then mercilessly attacked those futures with the intent of driving the price down as hard as they could, intending to pick up some nice bargains. Problem is the high-volume automated traders punched too hard, and ended up lighting off a stock-market panic. Automatic “safe-guards” kicked in to halt the markets, and regulators rolled back the clock and invalidated the panicked market-crashing trades.
This is simply the mirror-reverse of pump&dump, and is just as unethical. Half the trading volume or more on a given day is simply bots playing on the trampoline, trying to time their collective dives just right to get a good bounce.
Quotes must be valid for five seconds. Done.
Totally banned. I’ll say it again, the crooks who promote it lie when they say the big benefit it that it “provides liquidity” in tough situations, when in fact the opposite is the truth as we see on an almost weekly basis. Look up “flash crash” and you’ll see some eye opening examples, including the 1000-point drop in the DJII in 2010.
It is direct insider trading. They know what the trades are when they make their trades. Might as well say it is legal for casinos to place cameras where they can see your cards and they tell the dealers your hand.
Ah here we go:
After almost five months of investigations led by Gregg E. Berman,[7][8] the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) issued a joint report dated September 30, 2010 and titled “Findings Regarding the Market Events of May 6, 2010” identifying the sequence of events leading to the Flash Crash.[9]
The joint report “portrayed a market so fragmented and fragile that a single large trade could send stocks into a sudden spiral,”[10] and detailed how a large mutual fund firm selling an unusually large number of E-Mini S&P 500 contracts first exhausted available buyers, and then how high-frequency traders (HFT) started aggressively selling, accelerating the effect of the mutual fund’s selling and contributing to the sharp price declines that day.
-— snip -—
HFTs began to quickly buy and then resell contracts to each other – generating a “hot-potato” volume effect as the same positions were rapidly passed back and forth. Between 2:45:13 and 2:45:27, HFTs traded over 27,000 contracts, which accounted for about 49 percent of the total trading volume, while buying only about 200 additional contracts net.
http://en.wikipedia.org/wiki/2010_Flash_Crash
Investors are much better off than they were a generation ago. The bid-ask spreads are cents, or fractions of a cent.
HFT is skimming... it effectively widens the bid ask spreads on large orders, by maybe 0.1%. So, it should be discouraged as a market imperfection, perhaps by placing a minimum duration time on computer generated orders. But, IMHO getting people worked up about HFT as if it is the main problem in the market is a shell game. The real drain on market returns is taxation.
He gives himself up as a shill here. The same "fervent free marketeers" would by the same reasoning (profit = success) declare that any other criminal enterprise, like a big car theft ring, "has passed the 'market test'".
I heard somewhere a strategy whereby a big trading outfit would place there offices, and thus their servers/computers in NY as opposed to elsewhere in the US or the globe, for the purposes of getting that last nanosecond of time that would have been used to transmit bits over more miles, or more satellite hops, or more repeater hops, or fiber over copper.
Might a delay (ie, 5 secs) merely shift the problem by 5 seconds, but not fix it?
Sounds like a good problem for an operations research project, queuing theory, or something of that nature.
Perhaps the trading requests can be realtime, but the price knowledge be delayed 5 seconds. Then, the computers-as-instantaneous-traders would not have the advantage they now have. But, even that, they would still have enormous advantage over human traders.
There’s a very important difference between “delay” and “validity”. They put up these bogus bids and asks with no intention whatsoever of having the “order” filled, but to fake each other out regarding their intention, to move the market. Requiring those bogus bids and asks to become real, something that would actually result in a trade (that they don’t really want), would break the crooked back of HFT.
Ah here we go
Firms have made the news and been sanctioned by FINRA for spoofing. They spoof by placing small limit orders at prices that improve the national best bid and offer (NBBO) for a security, allowing the trader to take advantage of the improved prices by executing larger orders at another firm with execution guarantees at the NBBO. Once the larger order is executed at the artificially inflated price, the trader cancels the initial limit orders.
In one example, spoofing artificially impacted the price of a NASDAQ Stock Market security. The trader attempted to conceal his improper trading activity through the use of one of his 11 undisclosed outside brokerage accounts; he was fined $175,000 and is required to pay restitution of $171,740 for engaging in manipulative trading activity.
http://www.niceactimize.com/blog/index.php/2013/05/market-manipulation-high-frequency-trading/
Multiply that by infinity, and you have today’s “market”.
Long term capital gains: Assets held more than one year. Tax rate 15%
Short term capital gains: Assets held between one second and one year. Tax rate 28%.
Very short term capital gains: Assets held less than one second. Tax rate 99.9%.
Solved.
> Are you saying HFT should be totally banned?
It shouldn’t be banned, market rules should be changed to make it irrelevant. HFT is currently not much more than front running trades.
Very interesting...
I recall reading a book about trading shenanigans in the 80’s, and nothing has fundamentally changed since I guess. Just the mechanisms have evolved.
The book focused on the wheelings and dealings of the Specialists, that could trade on their own accounts with their own money, with the responsibility to maintain an “orderly” market for each stock they had to oversee.
Not just “in NY”, they have dark fiber feeds directly into the trading systems; i.e., no hops.
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