High-Frequency Trading – All’s Fair or a Cheater’s Paradise?
Should the fastest runner in a race get the prize, or is he a cheater with an unfair advantage because of his superior speed?
In effect, that’s one of the key questions about High-Frequency Trading (HFT).
The debate focuses on a particular aspect of High-Frequency Trading, where automated algorithmic traders use the superior speed of their technology to their own financial advantage.
In today’s article, I will examine this state-of-the-art technology and the explosive debate surrounding this divisive issue.
We all know that currently there is a growing number of proprietary autotrading programs, which are fast replacing human traders. In fact, at this point, they make up about half of the volume in the stock exchanges.
These automated trading programs, called “algobots,” can analyze a myriad of market conditions and buy and sell thousands of stocks in the blink of an eye.
Sounds fair enough, right? Well, here’s where the controversy begins:
Currently, these automated trading programs are able to use their superior speed to spot a slower trader about to make a trade. In an instant, the algobot can snatch up the shares he is about to buy, and then sell them to him at a higher price.
Here’s an analogy: Let’s say you and your family want to go to a concert. You go to an online ticket agency and see there are four seats all next to each other for $30 each. You put in an order to buy all four, and you get a message back that says, “You’ve just bought two tickets at $30 each.” But, what happened to the other two seats? Now, those same two seats have gone up to $35 each because someone else saw your order and before it could be filled grabbed up the other two seats and then offered them at a higher price!
What do you think? Is that fair-market competition or predatory behavior?
According to Larry Doyle, a critic, former trader, and author: “They’ve figured out how to front-run market orders,” and most front running is illegal, especially when brokers use information about their clients’ imminent trades to profit.
He makes a good point, and it’s a fair comparison.
However, proponents of this practice say it’s not front running. It’s just a better and faster way to analyze market conditions before trading.
According to Charles Jones, a professor of finance at Columbia Business School in Manhattan and an expert on high-frequency trading, “In general, somebody here has just invested in a better mousetrap, so why shouldn’t they get a return on that better mousetrap?”
In fact, he claims High-Frequency Trading may actually be making the markets more efficient, cutting trading costs and creating greater liquidity. He points to the narrowing bid-ask spread and the fact that because of this, you generally don’t pay more than a penny in terms of mark up to buy or sell a share. He adds, “So in a sense, there’s never been a better time to be a retail trader than in this automated world with high-frequency traders.”
Mr. Jones is certainly not alone in his views. For example, Clifford Asness and Michael Mendelson, executives at AQR Capital Management in Greenwich, Conn., believe High-Frequency Trading has helped their firm. “It seems to have reduced our costs and may enable us to manage more investment dollars.”
However, the critics continue by claiming that the Nasdaq and New York Stock Exchange are giving the smartest “algobots” an unfair advantage by giving them faster access to market information in exchange for their volume. In fact, these exchanges have allowed HFT companies to place their computer servers within their trading venues and provided them access to all sorts of ultra-fast, high-speed technological advantages.
The financial advantage this provides to HFT firms is huge. So much so that they are willing to invest vast amounts of money to get this slight edge. For example, one company reported laid a high-speed fiber optic cable from the futures market in Chicago to the exchanges in New Jersey. The cost? $300 million to shave just three milliseconds off the fastest route. Then, they leased access to high-frequency traders for $10 million!
What effect does this have on funds without the same high-speed access? One hedge fund manager said he was running a hedge fund that was $9 billion and he figured that just their inability to make the trades the market said they should be able to was costing them $300 million a year.”
New York Attorney General, Eric Schneiderman says, “Each of these services offers clients a timing advantage – often in milliseconds – that allows high-frequency traders to make rapid and often risk-free trades before the rest of the market can react. As a result, these traders guarantee themselves enormous revenue and force large investors to develop complicated and expensive defensive strategies to conceal their orders from parasitic traders.”
Personally, I see both sides of this issue. How about you?
Do you think this aspect of High-Frequency Trading is fair, or should the authorities do something about it? I would love to hear your comments below and as usual please share using Facebook, Twitter, etc.
Every trader must have the same advantages or, in other words, there must be a level playing field for all.
Another aspect to consider is : Why and how did the flascrash happen ? Was it caused by the combined actions of all HFT-traders ? If so, their actions should be prohibited.
Hi Dusting,
not sure what to believe, because nobody knows… however I want to chip in my 20 cents.
Michael Lewis is in a book-selling business and he doesn’t understand the domain he is writing about. I fast-read the book in a book shop and probably (most likely) missed important points and missed all meaningful real facts because couldn’t find any meaningful facts. Book really got under my skin, like most journalists when they are writing their opinions about something they have no clue.
Shortly; HFT is one of the three independent market participants. One missing and there is no markets.
In market there is trader (could be big or small institution or individual investor you or me) then there is an Exchange (like ASX or NY or NQ) and between them is a Smart Routing Firms to provide liquidity. Every order, sell or buy order is routed through Smart Order Routing Firms = High Frequency Trading firms. HFT firms have been around over 10 years. HFT has changed the industy fair bit for better.
As always, it is easy to forget the past. Lewis also wrote a book couple years ago The Liar’s Poker. And I suggest that he should read what he wrote then. I will borrow his own line… “Those who know don’t tell and those who tell don’t know.” Did he lie in the first book or he doesn’t understand what HFT is and is now telling nonsense. Does he understand who the customer is? What this book is all about is…. Book-selling-business. When you pick easy targets, like Lehman Brothers, Bears etc. and create sensation (good for selling books) and start to make your own assumptions and create fantasy narrative, with 50 miles view, without any knowledge of your subject. And start focusing to only very narrow view. He may be fine writer and will for sure, make millions with this book. Particularly when The Lame-Street Media has even less ideas what it is about the HFT and is ready to give him free promotions. Thing which bothers me a bit is that people are actually reading his book and listening his rubbish. Because, all this brouhaha is giving to people is very narrow, skewed, sensationalistic view offered as a fact. And promote view of big institutions scare tactics, who are too lazy to engage and invest to the technology and want us go back to use of “horses and carriages” open cry bit so they could get back to the golden days when they had bigger slice from fees. Now these institutions Goldman’s, Morgan’s are crying wolf when others HFT firms invested hundreds of millions to the tech and are collecting fraction of the penny from the trades. Trades what in the past Morgan’s et all collected minimum $30 bugs.
Chairwoman of the SEC was quoted in Time Magazine some time back. “The SEC says the results of a new agency computer program called MIDAS, which can track trading down to the microsecond, have shown that, for the most part, high-frequency trading is not undermining fair and competitive markets. ”Ms. White went to say, “If we fail to serve and safeguard the retail investor, we have not fulfilled our mission.” The undeniable winner of HFT is the DIY individual investor.
Smart Order Routing (HFT) allows everybody including every institutional fund to get their order to the best possible price from 11 different exchanges. Every single order goes through HFT.
High Frequency Trading (HFT) is providing liquidity to the markets. Computers have replaced “market makers”. No more arb in a Open Cry Pit, where sellers and buyers agreeing a price created inefficient and slow way to mark to mark price and as result markets (the spread between bid and ask) were really wide. So wide that some instruments like commodities were nearly impossible for individual investors to invest or trade.
Here are some facts:
HFT pushes prices lower or higher and this benefits institutional buyers as well everybody else. Not every trade is a buy order, 50% trades are sell orders .
HFT has reduced institutional trading costs by billions of dollars (the ratio of saving to cost is over 10:1 minimum, could be in some cases be as high as 30:1).
HFT has reduced exchanged fees and content fees for most institutions.
HFT has forced institutions to commit to more efficient marketplaces like large dark pools.
HFT has forced institutions to ramp up legacy technology and front end analytics. Lazy institutions didn’t want to spent money to the technology, they got bigger slice.
HFT has improved the domain IQ of institutional traders by huge multiple. New traders (22 year old) fresh from Uni with zero knowledge of trading used to start handling billions, now they have been forced to learn, no more unfair advantage of front running from feed information from content, pre-sell material sellers like Reuter and Bloomberg etc.
HFT has forced institutions into more liquid underlying’s more occurrences and more diversification. Making markets much safer for small guy.
HFT has done away with many of questionable soft-dollar IPOs, payouts and rebate tactics.
HFT has put industry analysts and traditional news sources who pre-sell material information on notice.
HFT has challenged the institutional space to use alternative products and non-traditional strategies.
HFT has exposed the massive fee based business (mutual fund industry and financial advisors and financial planners, super funds etc.) for what they really are (an expensive underperforming index funds). These fee based business are just collecting fees to enter, fees to keep account, fees to get out, and 20- 30% “performance” fees etc. fee after fee on top of another fee.
Benefits for individual Investors are immense.
-Tighter broad markets. -More overall liquidity in the top few hundred stocks. -More product innovation. -Better front end technology. -Faster routing technology. -Better content and cheaper. –Better strategic education. -Lower transaction costs. -Lower exchange fees. – Margin benefits like PM accounts, like portfolio margin accounts which did not exist before e HFT. –Retirement account benefits like complex spreads and futures. –Significantly greater percentage of price improvement. –Better margin and money rates. –More successful traders due to more activity. –Easier record keeping for tax purposes. None of these things existed before HFT.
Cheers
Taito Peura
Individual Independent Investor and Trader
It’s front running. The algorithm doesn’t ‘know better market conditions’, the algorithm looks at the trade the legitimate buyer wants to make, -that is why- it knows what the market condition is. If it had not been for the legitimate buyer’s input, the algorithm wouldn’t know what to buy/sell.
Besides, entering and leaving positions in milliseconds is not investing in the stock market. It’s a numbers racket. Because of their interference in the market they don’t ‘provide liquidity’, because they’re making it more expensive for the legitimate buyer, they’re effectively taxing the transaction.
If taxing transactions is what they want, I want their transactions, which have nothing to do with investing in companies, taxed at 20%. That is: 20% entering the market and 20% leaving the market.
These people are treating the market as their very own piggy bank that they can tap into, make everybody pay more money than they had planned to, and then reap the tax-free benefits from.
You invest a little bit of money up front, then you get to snore all the way to your first billion.
At the same time real people need to work for every lousier conditions, making really bad pay -and- paying actual taxes. These people don’t get a break, they get the short end of the stick.
High-frequency trading is luxuriating on the sweat of others. It adds precisely nothing of value to the equation. It has to be taxed ‘to the extent the market will bear’.
I understand that HFTs do create a more liquid market and reduce some costs. The problem I have is they have no risk in the game and their is no investor privacy.
I think is not appropriated, is not fair
hello dear sir tank you for your analysis but i think That high fréquence trade help us to have More volatility and is verry good for all all daily trader i m work in forex market and commodities since 10 years and nothing change for me i won money More thanatos 2008 That s it all the best Philip
I my humble opinion, asking the government for more regulation is asking for trouble. I trade binary options on Forex, and I know that already U.S. traders are shut out of many good brokerage firms across the globe due to U.S. regulations. Traders are also shut out of some markets and binary trading opportunities due to U.S. regulation. There are ways to make money in spot Forex as well as in Binary options on Forex, but it is not easy. As most reading this post understand, it takes a lot of hard work and focus to become a good trader regardless of which route one chooses to take. Stay focused.
high frequency trading is very legit(the use of robots,EAs and other legit trading programs), the only part that should be illegal is when a high frequency traders pays huge amount of cash to a broker in order to have access to other traders orders,thereby making money from their trades without risking a penny. that is not trading that’s worst than inside trading. In inside trading the inside trader risk his/her cash, where as in the HFT case the HFT traders only waits for a legitimate buyer/seller to place an order then he quickly buys/sells to the victim at higher the rate, making huge profits.. This is very illegal buts its gonna be hard to stop this because am very sure most of the parties who should be regulating the market are making huge income from these illegal mess…
Yes, this activity should be illegal. One firm reported only one daily loss in two years; that was human error. The fact that these firms are so secretive about profits is only an indication that they are getting away with theft. They are front running. I would never use a market order, as you are asking for trouble. Yes, there is no risk for these guys; they have created money machines.
HFT AND THE EXCHANGES THAT HAVE ALLOWED THIS “WIRETAPPING” SHOULD GO TO JAIL. BOTH ARE PARTNERS IN THIS INSIDER TRADING ON INSIDER KNOWLEDGE! THE RICO ACT SHOULD BE USED AND ENFORCED IMMEDIATELY TO STOP THIS FRAUD AND GREED!