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Don't fear high-frequency trading
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Bill Radke: We talked earlier in the show about how small investors are fleeing the stock market. We gave some possible reasons -- maybe they're nervous about the economy, maybe they prefer the safety of bonds. Or maybe people are just still freaked out from the "flash crash".
Remember the stomach-dropping plunge this spring when almost 1,000 points just vanished from the Dow in just a few minutes, and then reappeared just as fast? Well, a group called the Financial Industry Regulatory Association is still struggling to explain exactly what happened. But over the weekend, it announced a probe that could lay some of the blame on high-frequency trading. We've told you about these -- those high-tech,
high-speed computer trades that now account for most of the buying and selling on Wall Street.
Well, commentator Matt Samelson says high-frequency trading might sound intimidating, but let's not make it the enemy.
Matt Samelson: Wild swings in the stock market always trigger a hunt for a bogeyman. Short sellers used to be the favorite target for blame, then algorithmic traders. Today, it's high-frequency trading.
It's easy to blame high-frequency trading, because most people know little about it. Talk of superfast computers and complicated algorithms makes it sound like a sinister plot line in the movie "The Terminator."
In reality, high-frequency trading is quite simple. It generally involves the frequent buying and selling of securities to profit from small changes in prices. The computers used in high-frequency trading are extremely smart: They're programmed to spot the best time to make the trades. They're quite fast, too: Orders are often executed in about one-ten thousandth of a second.
Being faster, and maybe even smarter, than a human trader isn't a bad thing. High-frequency strategies squeeze every ounce of value out of the market in ways that humans can't. They add value in other ways, too. In some instances, they buy and sell stock purely to collect rebates. By doing this, they provide shares that otherwise wouldn't be available, easing the pressure of supply and demand. They also identify stocks in which the market price has diverged from fundamental value. In taking advantage of these instances they correct the mispricing, pushing market prices back in line with fundamental price.
In other words, rather than creating problems in the market, high-frequency trading often solves them. It provides more stock for people to buy and sell, it often results in better execution prices, and it helps smooth out the ups and downs in price movement.
Nobody has yet managed to work out what caused the near 1,000-point drop in the Dow on May 6, but we do know that high-frequency traders helped correct the problem. The tremendous drop in the market prices of certain securities was stopped fairly rapidly thanks to high-frequency traders. They were the first to see prices were far lower than they should have been. They bought in, and they drove the market back, almost to where it had started.
It's true that high-frequency trading is reshaping our stock markets, and it's right that regulators should want to investigate. Hopefully, once regulators and legislators gain a full understanding of HFT, they'll see the enormous benefits that it can bring. Hopefully, then, we'll stop hearing paranoid rants about the rise of the machines.
Radke: Matt Samelson is a principal at the independent consulting firm Woodbine Associates.
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I know this is and old story, but I could not stop thinking how can someone admit publicly that they do manipulate the stock market, which is the back-born of capitalism!
" it often results in better execution prices, and it helps smooth out the ups and downs in price movement"
"They bought in, and they drove the market back, almost to where it had started."
So ultimately are you saying that high frequency traders are trying to bring socialism in Stock market?
And still everyone else should believe that no one is making any money out of that? So is it run by a non-profit organization with a salary cap for its executives with a figure not too far above that of an average US worker?
God only can save US.
I love the statement, that the HFT's/ECN's/MM's, inject liquidity and provide a valuable service to the market...they provide liquidity when it's convenient and narrow the spreads for the bxa again...when convenient. They provide anonymity to predator's to steal money from investors.
Matt Samuelson stated in his postscript: "Making money isn't "bad". Making money by ripping off SOMEONE ELSE is bad." Precisely. HFT rips off everyone who doesn't have the privileged access to the exchange data that HFT systems do. It destroys any remaining pretense that exchanges implement a level playing field for ordinary investors who wish to obtain the best price for their purchases or sales.
Is is a pretty bold claim when people say that HFT firms improve prices or efficiencies. It may improve prices and consequently profits for HFT firms, but I really do not believe over the long-term the market would be valued any less in the abscense of HFT firms. The arguments by proponents of HFT really do not make any common sense.
Thank you all for your comments.
A few things that I would like to point out:
1. Though not mentioned in this commentary, our firm did quite a bit of quantitative research on high frequency trading. We have published results and made them available to the professional investment community and legislators.
2. Our firm has no ownership by or allegence to any firm active in the capital markets. We do not invest or trade. In short, we are completely and wholly independent. If our research had shown HFT to be negative, we would have stated that. Our commentary in that case would have been negative.
3. High frequency trading IS good for the market because it promotes efficiencies. Overall, it has improved prices and efficiency in the market. If you go on line through your favorite discount broker and execute a trade, the market is "tighter" (the bid and the ask closer together) than they otherwise might be without HFT. If you lift the bid/take the offer in such a market you are getting a price closer to the securities fundamental price (the midpoint of the bid/ask spread) at your time of execution.
4. Making money isn't "bad". Making money by ripping off SOMEONE ELSE is bad. There are - absolutely - high frequency strategies formulated simply to anticipate price ahead of "slower" traders. We would agree these strategies should be banned from the market. These strategies do not constitute the majority of HFT.
5. High frequency trading firms ARE making a lot of money. But they provide a valuable service to the market as well. If they profit by correcting security mispricings or tightening the relationships among markets for different instruments - so when YOU buy or sell a security it is more representative of its true value, is that a bad thing?
6. We are a "commercial" for no one. We are an advocate for fair and efficient markets for everyone.
The point is: Eliminating ALL HFT hurts everyone. It is important for legislators and regulators to fully understand the different types of HFT and its impact on the market to maintain optimal market efficiency and fairness for everyone.
Thank you.
Mr Ron Baron of Baron Funds recently commented on HFT in his quarterly report (see www.baronfunds.com) suggesting that the SEC 's implementation of regulation NMS (national market system) effectively eliminated the exchange specialists who executed orders on the floor in an orderly manner, and made about $200 million/year for keeping this order. Now we have HFT trading which generates about $20 Billion/year for the 300 HFT firms; representing an approximately 4 cents tax for every non-HFT share traded. Since implementation of this HFT the daily volume on the NYSE has nearly tripled from 2.1 billion shares to 5.9 billion shares with 73% of shares traded daily being so-called HFT.
Indeed, Mr Samelson, we investors have a lot to be concerned about!
Wall Street, as a colleague of mine commented,is a "ponzi scheme for rich people". Now,with High Frequency Trading, it seems that computers are at the card table playing against each other. This entire set-up is quite disturbing, since as "regular folks" we lack options when it comes to our retirement and a lot of us our sour on wall street. I heard someone from the Wall Street Journal being interviewed recently (sorry, don't remember his name, but i believe he was a high-flying editor) that "All Americans want to be RICH! "Well, that is the carrot that keeps people pouring millions into their 401-k's and Wall Street but it is a fallacy and is simply a lie (i refuse to say "untruth"). We want to stay in the middle class and retire with a decent nest egg. We want to give our kids a hand up.
The few on the top are making money from the rest of us. His stance on the High Frequency Trading is disturbing because it feels like a public relations ploy for more elaborate gambling.
As recent history has proven, wall street loves private profit and public risk.
Matt Samuelson got it partially right yesterday. The problems wall street experienced are not the fault of high frequency trading machines. The problems, as with most innovations, are with unintended consequences. The people implementing high frequency trading fail to recognize how their implementation actually changes the game. It is similar to the problem a lot of companies experienced when they first put e-commerce in place. What they did was take their traditional manual process and teach a machine to do it the same way, but faster. However, those same processes didn't work so well when they were exposed to different expectations and a different environment in e-commerce. High frequency trading will become the norm, but regulators are right to be cautious until they begin to understand the implications and controls required to manage that environment effectively.
Hey, wake up! We've been here before. Doesn't anyone remember ARBITRAGE from the last century? It seems to me that Matt Samelson's apology for HFT exhibits the very same values (or lack thereof), goals and techniques that made millions for the likes of Ivan Boesky and others of his ilk at the expense of REAL investors, and eventually landed some of these traders in the slammer.
To "...squeeze every ounce of value out of the market in ways that humans can't..." is just a white-wash of the real goal of HFT -- and of every arbitrageur from the last century. That goal is to "...squeeze every cent out of the market (in ways that humans can't...)".
I hope that the Securities and Exchange Commission will dust off its archives on deleterious arbitrage practices when it gets around to checking out this trading practice.
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