High Frequency Trading: We Fear What We Do Not Understand

"For those who believe, no explanation is necessary. For those who do not, none will suffice." - Joseph Dunninger.

I've resisted writing a piece about high frequency trading lately. Although I have a very good understanding of the subject, I see it as a kinda lost cause to try to educate people about - uninformed people want to believe that computers are front running them, stealing their money and manipulating the markets. People who understand equity trading know that this is just the culmination of technology advancement and competition for spreads, which has resulted in equity bid/ask spreads being narrowed to their lowest levels ever. There has never been a better time for the individual stock trader to execute orders: our bid ask spreads are narrower than ever. A high frequency trader may have a computer program trying to scalp a penny or a fraction of a penny from you - but this is better than it's ever been - better than the days of specialists scalping 1/8ths and more.

I left a comment stating as much on Floyd Norris's latest article "What Should be Done," only because he got it precisely backwards when he wrote, "In one sense, this is a return to the bad old days. Before reforms, the Nasdaq market kept the bid-asked spread for the brokers. The public had to buy at a higher price and sell at a lower one." On the contrary - high frequency trading has resulted in competition to capture those exact spreads, and has narrowed them drastically.

In my opinion, reaction to high frequency trading is all about the quote at the top of this post if you change the word "believe" to "understand." I will at least try to educate those who do not understand high frequency trading, so that they can form intelligent opinions - although I still fear that "no explanation will suffice."

Joe Saluzzi of Themis trading has gotten a ton of press based on a paper he published about the evils of high frequency trading. It's important to notice that Saluzzi is an execution trader, and that algorithms and high frequency traders make his life very difficult, because no human can do the job as well as an algorithm can. Saluzzi concludes his paper: "We also recommend that institutions use algo systems only for the most liquid of stocks. Anything less must be worked, the same as in the 'old days.' Institutions need to re-learn how to 'watch the tape' and take advantage of, or work around, high frequency traders." Or, institutions can embrace technology and use or develop better algorithms. Either way, Saluzzi's suggestion that it's kosher for him to execute the orders by "watching the tape" to gauge optimal timing, but that it's unfair for a computer program to do the same thing reeks of hypocrisy. The best comment I've read on the subject was this (emphasis mine):

Frontrunning is trading in front of a customer order. It is illegal. Collecting and analyzing publicly available information and trading based on your insights is legal. And guess what, someone will be the fastest and most accurate in doing this. The result of their actions is to translate meaningful information (strained from a stream of mostly noise, it's incredibly difficult to do) into price changes which make the price more accurate relative to what's knowable at the time. Unfortunately for people like Saluzzi, a 19th century "tape reader", a lot of the information that quicker, more talented, machine-using, more insightful players uncover is information about large size that he's trying to deceptively move without anyone knowing the truth about what he's doing. There's nothing wrong with what Saluzzi is trying to do. What's wrong is crying foul when the one-sided benefit you wanted to obtain is defeated by people who have made a bigger investment in what's important for trading. The big winners in all this are small traders who are not fleeced by large professional size deceptively getting them to buy or sell at insufficient prices. I can understand Saluzzi's campaign against technology and modern information processing, it's his ox that's getting gored. The thing that's truly hilarious is that what Saluzzi wants to be legal, his "tape reading", is just another example of where professionals have an edge over the little guy. But it would never occur to Saluzzi to outlaw what HE does, only what his competitors are doing better than him.

Let's get one thing straight: front running is when someone sees your order and executes ahead of it. It's illegal, and no one is advocating it. What many of these high frequency trading algorithms do, however, is not front running. High frequency trading is about using computers to do what human traders used to do - take advantage of available information (such as orders that are visible in the marketplace) and try to figure out where a stock is going. They do it better than humans can do it. They try to figure out what you want to do, and try to profit from what they think you want to do. They do it faster and more accurately. That's called trading - it's the nature of the beast.

If you put in a limit order to buy 100 shares of IBM at $80.50, and a computer or anyone else immediately bids $80.51 for IBM, that's NOT front running. That's someone willing to pay more for the stock than you are. It doesn't matter if that someone hopes to buy the stock and offer it back to you immediately like a high frequency rebate trader, or if they plan to hold it in their IRA for 50 years. Similarly, if, at the time you bid $80.50 for IBM, stock is offered at $80.51, and as soon as you put your bid in someone takes the offer, that's NOT front running. You had the opportunity to take that offer - you chose not to. This is the first key realization people need to make.

The next realization is that no algorithm can force you to pay more than you want to for stock. One thing the algo's do is "psych you out" - when you bid $80.50 and you see the $80.51 and $80.52 offers get lifted, you might get nervous and panic. That's your problem. If you put your limit order in and go to the kitchen to make yourself a sandwich, you'll probably find that your order is filled when you get back. Any algo that expected you to panic and lift stock from them lost on their gamble. You can defeat the psychological game by refusing to play it (place your order and don't stare at the screen) - or by lifting the offer in the first place, paying the narrowest spread you've ever paid due to the massive competition by various high frequency trading algorithms to maintain quotes on the inside market.

Let's talk about Chuck Schumer's proposed ban on "flash" orders. Flash orders are a little bit trickier. From the NY Times article:

When buy or sell orders are submitted to marketplaces like Nasdaq, they are sometimes flashed to a collection of high-frequency traders for just 30 milliseconds — 0.03 seconds — before they are routed to everyone else. In that half-second, (sic) fast-moving computer software can gain valuable insights regarding growing or declining demand in certain stocks and can trade ahead of other market participants, pushing prices up or down.

Although anyone can gain access to flash orders by paying a fee, they are useful only to traders who have computers powerful enough to act on the data within milliseconds.

First, note that ANYONE can gain access to flash orders. Similarly, anyone can gain access to co-located servers at the NYSE to have super fast execution speeds. These are not just available to a select chosen few - they are available to anyone who wants to make the investment in capital and technology. Now, the intent of flash orders is to allow participants in a given market center the opportunity to improve the current bid or offer so that an order doesn't need to be routed away to another market center.

An example: let's say GE is trading $11.45-$11.50 at DirectEdge, but that there is an $11.46 bid on ISLD (an ECN). If you submit an order to sell stock at $11.46 on DirectEdge, they flash this order to select market participants to offer them the opportunity to fill your order - otherwise the order gets routed out to ISLD and you (the seller) have to pay an extra fraction of a penny for the routing. As I tried to explain on some other posts regarding flash trading, this is basically a hyper-speed modernized version of how the NYSE specialists used to verbally quote orders to offer people in the crowd the opportunity for price improvement: "If GE was 11.25-11.27 50k up, and you walked in to sell 50,000 shares, the specialist would say out loud '25c bid 50,000, 50,000 at 26c, SOLD.' Anyone could say 'TAKE or BUY'EM' before the specialist said 'SOLD' which would result in the seller getting price improvement to $11.26 and if no one interrupted him, the trade was done at $11.25. Markets have NEVER been setup such that every participant has the same opportunity to trade on every quote."

The problem is if systems receiving flash orders can then turn around and hit that bid in front of the seller. That is blatant front running, and needs to be stopped. Here's a quote from a user of flash quotes explaining why he doesn't want them banned - a key point is that no one forces you to place flash orders:

responding to: "there are different forms of HFT. Flash is clearly frontrunning and anyone who says otherwise is delusional. its designed to cheat "

Not true.

It is designed to keep orders from being routed-out under Reg NMS - which saves the person placing the trade money.

I am a small fry (sole employee of my small stat arb company) placing small to modest sized limit orders directly on ECNs. If I want to avoid paying a route-out fee when my order would otherwise become marketable on another exchange or ECN, the best execution + cost structure that I can get is to first have an order flashed locally to see if I can have a fill on the local ECN.

If a HF trader on the ECN gets the flash and 30ms later fills my order, I avoid paying a route out fee. If no HF trader responds to the flash, or the flash never existed because it got outlawed, then I end up paying a route out fee.

That is the intent behind flash orders. It keeps orders that become marketable more frequently on the local ECN rather than having them route-out....

I keep saying the same thing over and over again... but anyone who cares about orders flashing and doesn't want them to flash should just send the order through a different venue. It isn't rocket science. If you don't like the facilities provided by Direct Edge to execute your market moving large institutional order, then place it on Island.

Why is that so friggin hard?

No one is forced to place any order types that they don't like, or use any ECN that they think disadvantages them.

If your broker forces you to place trades on venues that flash orders and you have no control over it, then you need to get a better broker.

Outlawing an order type that some people actually like to use under certain circumstances is ridiculous.

More constructively - make flash default to off, so that a trader needs to explicitly ask for a flash, and make all brokers who don't pass on fine grain order control to their customers set the default to off...."

I'm somewhat indifferent when it comes to flash orders - on the one hand I don't care if they get banned if they are being prolifically front run, but on the other hand I like the suggestion of defaulting the flash order status to "off" and allowing traders to still flash their orders to try to get price improvement. If traders are getting worse executions on their flash orders because they are constantly being front run, then they will stop using them.

Let me take a brief detour to negate one blatantly erroneous insinuation made in today's Financial Times article:

Themis also suggests reintroducing the New York Stock Exchange's curb on program trading that would apply whenever the market was up or down by more than 2 per cent for a day. This constraint was removed in October 2007, which is - maybe not coincidentally - when world stocks peaked.

The NYSE never had curbs that prevented program trading. The NYSE used to have curbs that imposed restrictions on index arbitrage orders, a specific subset of program trading, after market moves of a certain magnitude. The curbs ensured that index arbitrage buy orders had to be executed on a downtick, and that index arbitrage sell orders had to be executed on an uptick. It's basically like the uptick rule for short selling, only it applied to buy orders as well. This had little or nothing to do with high frequency trading, and is completely irrelevant to the discussion, except for the ludicrous assertion that the removal of the curbs somehow may have led to the depression of the markets. If Themis thinks that high frequency traders are manipulating the market higher, they need to realize that the reinstitution of NYSE index arb trading curbs would have no effect.

While I'm on the topic, let me debunk a few more of Themis's blog posts. Saluzzi's assertion that high frequency traders were manipulating the price of CIT higher so that it would be eligible for a rebate was proved wrong before he even published it, when the price failed to maintain the $1 level. CIT was trading massive volume because it was in the process of basically declaring bankruptcy - not because HFT guys were manipulating the price. Second, Saluzzi's post titled "The Three HFT Horsemen" is perplexing. He alleges:

The three HFT horsemen are C, BAC and CIT. These three stocks traded 860 million shares today which is 10% of all US Equity volume. Think about that – 3 stocks in a universe of over 5000 U.S. stocks represented 10% of the volume. How could this be? Look at the intraday chart of all three of these stocks and you will see a something in common: an early morning move followed by a flatline with a very tight range (around .05). Meanwhile, while these stocks were flatlining the market was heading higher. The S&P 500 gained around 10 points in the afternoon (or 1%) but these 3 stocks did not move. There was a constant bid to these stocks yet anytime they wanted to lift there seemed to be a constant offer just a few pennies higher.

Never mind the fact that C and CIT are low priced stocks that should theoretically trade in tight ranges: what is the problem with this? As a trader, Saluzzi should be sending thank you notes to the high frequency traders for making sure the price of the stock didn't move much at all - this makes his job easy, regardless of if his client is a buyer or a seller of stock. There was ample liquidity all day, and the prices barely moved. This is a good thing.

I am a capitalist. I like competition in markets. Our competitive markets have resulted in evolution to the point where traders have written computer algorithms that do the job traders used to try to do by hand - profit from stock movements and from what they feel net supply and demand for a given stock is. This is the main reason I'm against most attacks on high frequency trading. SOMEONE will always be the best - the fastest - the closest - regardless of if you ban co-located servers, or install mandatory latency in order execution pipes. Would there be anything really wrong with making sure that all orders placed are valid for a 1/2 second or a full second? No, I don't think there would be - and that might be the kind of compromise that we move toward - but we need to recognize that the playing field will never be level. It never has been level and it never will be level - there is always someone smarter than you, and it would be a shame to try to legislate that edge away.

Full disclosure: No agenda here: I do not run a high frequency trading system, and a ban on HFT would not have much, if any, impact on my life. Market position: short the market.

Comments

[miser:]

i believe yours is the correct view. what's really going on is a battle between the marketplaces and the nyse is showing an impressive ability to place articles in the NYTimes articles and get a prominent senators to write a letter to the sec chairman -- something we haven't seen since the days of Grasso. How ironic that the Big Board is fighting what is really a kind of electronic replication of the crowd that used to stand around the trading post on the New York floor. for all i know flash trading may be a bad thing but the front-running charge is just a smear which the smallest measure of critical thought will reveal. flash orders involve sophisticated players flashing to other sophisticated players. a flashed order is one that would lock the market if it were displayed publicly. the advantage garnered by flashers is the opportunity to receive a rebate rather than pay a fee. the advantage garnered by the recipients of flash orders is the privilege of trading WITH them, not in front of them.

Jul 27 01:01 PM

[swaps:]

Robespierre and Nick36 should have written this posting instead of Dynamite.
I have two bound copies of Graham and Dodd's Security Analysis.
This once classic advice on investing is now worthless, or at least moot because investing has been replaced by trading.
I agree with those who think draconian taxes should be levied on stock buys that are held for moments, minutes or just a few hours.
Coin clipping was a common larceny in the middle ages. After a few clips I recall some proto banks and sellers would refuse to accept a mutiliated coin, considering the coin of diminished valued.
In this same way the continual electronic coin clipping is diminishing the value of stocks.
I can see where KD is coming from. Trading is for the big boys and if you can't keep up with Brandon Marshall then leave the NFL and go play in your street teams.
But setting up your computer and paying a "fee" - a bribe? - for early inside information to chisel something out of each stock is not adding to the value of America. It is not building America. It is just nickle and diming America down to a lower level.
Congress - which has been brainwashed to allow the destruction of the U. S. manufacturing and production base - won't care about stock market clipping either. They don't see the lack of a moral center behind it
Time and again Congress and the overseers have failed to grasp the big picture.
This is just one more example.

Jul 27 01:40 PM

[speeddaimon:]

I just looked at your first comment. It was completely useless anyway and at best, inane. Then the next 7 comments have just been a repost of this one. Here's a thought. Log out, create a new account, put in a username instead of your name. then you can be ignored at the same time you're anonymous.

I'm amazed you managed to turn the computer on by yourself.


On Jul 27 12:33 PM Renee Cummins wrote:

> I am trading my name because Seeking Alpha made it a public item.
> When registering for a comment to an article, as most registratinos
> require, it asked for (and got) my first and last name. Nowhere else
> have these names been automatically published before. Where they
> do not ask for a preferred username, it ialways defaults to the email
> address. This website unethically uses the first and last name without
> asking for an option. And, when you try to edit your first and last
> name in the user profile, although it has a section to edit "username,
> logon & email" it only allows you to change your email and password.
> My full name is publcily displayed, and they rrefuse to answer their
> phones. Anyone want to buy my name?

Jul 27 01:42 PM

[ValueInvestor:]

The author says: "First, note that ANYONE can gain access to flash orders. Similarly, anyone can gain access to co-located servers at the NYSE to have super fast execution speeds. These are not just available to a select chosen few - they are available to anyone who wants to make the investment in capital and technology."

This might be true in theory, but in practice the prices the exchange charge are too high for the majority of smaller Firms and therefore it is only realistic for the "big boys" to use this info. This isn't a fair system.

Jul 27 02:02 PM

[kohalakid:]

Today's markets are certainly a long way from the days of 1/8 and 1/4 spreads. How any long term investor can moan about the liquidity provided that enables $50 stocks to trade with a penny spread is beyond me.

If you are a long term investor you should be grateful for the tight spreads.

If you are a speculator or day trader or scalper you should realize there are always bigger, faster and smarter fish in the pond.
If you haven't figured that out, you're gonna be lunch.

Jul 27 02:28 PM

[Mr. Ed, Jr.:]

We are getting a lot of "spin" from all sides of this subject these days. Everybody telling everybody else, "You don't understand..."

Maybe I don't "understand". But if GS is able to see an order -- on either side-- before others, and then step in front of it to gain an advantage (Beat someone on either side out of a penny), it needs to be stopped.

All of the theoretical arguments about "You put in a bid, and you got your price, therefore you have not been harmed" are a load of youknowwhat. So is the argument about it being the same as the trading floor-- do we really even need a trading floor ? That seems to be more for public consumption (It looks exciting on TV) than reality.

Same for the silly argument that it is available to anyone. Unless, of course, you mean anyone who can spend a fortune to have such a program created and installed at the exchange building.

There is no good reason to allow GS or anyone else to beat a trader out of a single penny by seeing an order a split second ahead of others and acting on it. (If that is what is going on)

And maybe Congress can do something useful for a change-- hold public hearings on this so that we all can "understand".

Jul 27 02:29 PM

[miser:]

ok let me try to take this on one more time. pay attention.
introduction: there are two claims against flashed orders --
that they facilitate front-running, or that they facilitate
jumping ahead of displayed orders. both claims are naive and
false. all that's really going on is a fight over who pays
the fee and who receives the rebate at the inside market.
or, put another way, given that there are fees and rebates,
flash orders represent a method of getting inside the one-penny
minimum increment based on who pays the fee and who receives
the rebate at any given price. without flash orders the seller
pays the fee and the bidder receives the rebate when the trade
occurs on the bid, and the buyer pays the fee and the offerer
receives the rebate when the trade occurs on the offer. flash
orders permit sellers to attempt to shift the burden of the fee to the buyer on trades that go off on the bid, or they permit buyers to attempt to shift the burden of the fee to the seller for trades that occur on the offer.there is nothing nefarious or hifalutin about any of this. it's just a form of price discovery in very fine increments. now let's have with some of the regulatory background. flashed orders are permitted under the cok let me try to take this on one more time. pay attention. introduction: there are two claims against flashed orders -- that they facilitate front-running, or that they facilitate jumping ahead of displayed orders. both claims are naive and false. all that's really going on is a fight over who pays the fee and who receives the rebate at the inside market. or, put another way, given that there are fees and rebates, flash orders represent a method of getting inside the one-penny minimum increment based on who pays the fee and who receives the rebate at any given price. without flash orders the seller pays the fee and the bidder receives the rebate when the trade occurs on the bid, and the buyer pays the fee and the offerer receives the rebate when the trade occurs on the offer. flash orders permit sellers to attempt to shift the burden of paying the fee to buyers on trades that go off on the bid, and they permit buyers to attempt to shift the burden of paying the fee to sellers on traders that occur on the offer. this is permitted under current rules because an order that would lock or cross the market is not required to be displayed. sellers clear out the bid in a marketplace and while stock is still bid there away they flash offers at that price to participants in that marketplace. why? because they are attempting to sell on the bid while receiving a rebate rather than paying a fee. okay. now let's take the front-running argument first. an order to sell gets flashed to potential buyers when the bid at that price has just been hit. stock is still bid at that level away but the seller has cleared out the visible size in one marketplace in order to flash an offer to participants in that marketplace. those participants see that there is a seller at the bid price. they are in a position to run in front of this seller. how valuable is that information? remember, the bid just got hit -- that's what permits flashing a sell order at the bid price. it just got hit visibly, in front of the entire world. but the recipient of the flash order learns an additional piece of information -- that there is more for sale but only at the bid price plus a rebate, not at the bid price minus a fee. generally that's good for a few hundred shares, and for a few milliseconds. as potential front-running goes, that's not exactly 'seller's got a few million more where that came from.' you can generally bet that the recipient of the flash order is interested either in trading with that order or not trading with it, not in front-running it. which brings us to the second, equally naive, hypothesis. The recipient of the flashed order appears to cut the line. You might concede he cuts the line legitimately, apparently, by the locked-market loophole, but cuts the line nevertheless. The displayed bidders were waiting patiently, but then someone else comes along and trades at their price. But you have to concede it isn't exactly cutting the line, since trading with the flashed sell order means paying the bid plus a fee, something the displayed bidders weren't willing to do. they were willing to pay the bid and receive a rebate. Ah but you might argue that, sure, the recipient of the flash order is paying more than the displayed bidders were wiling to pay, but we don't really know -- you might argue -- that the displayed bidders -- -- those poor, hapless displayed bidders -- aren't willing to trade at the bid plus a fee. they haven't been offered the opportunity. doesn't the jumping ahead occur when the opportunity to trade at the bid plus a fee is offered to the recipient of the flash order and not to displayed bidders. uh -- no -- for the simple reason that in all likelihood and in most cases the displayed bidder IS the flash recipient. who do you think was sitting there on the bid in the first place? if he's interested in paying the bid plus a fee then he's willing to pay the bid less a rebate, too. in most cases it is the same high-frequency buyer (or buyers) -- his bid is displayed in several marketplaces. he is hoping to get hit. he gets hit in one marketplace and gets flashed stock at a slightly higher price than where he just bought. does he wait and hope his bid gets hit so he can collect the rebate? or does he accept the flashed order and pay the fee? an arb trader with a profit inclusive of the fee will accept the flash order. so too will an institution with an algo that is tilted aggressively in that situation. otherwise they will both wait and hope their bids bid get hit.

like i said, you have to pay attention. most folks appear to prefer demagoguery to facts on this issue. you're being manipulated all right, but not by the high-frequency traders. you're being manipulated by the new york stock exchange -- the guys who placed that article in the new york times and got schumer to rattle shapiro's cage. think about it. that great friend throughout history to the retail trader and the individual investor, that champion of innovation and competition -- the new york stock exchange.

Jul 27 11:21 PM

[Moon Kil Woong:]

Unless you are a computer it's hard to place buys and sells ever millisecond let alone change the price. And if you are not a specialist, it is impossible to do it even if you are capable of it. Also computers don't make sandwitches nor eat or crap, so yes, being human is a distinct disadvantage.

How else does high frequency trading help? If you can parse out every trade by millionths of a second you can more easily determine who is placing orders and what they are. Likewise, with you trading a majority of the volume other people who don't have access to the millionth of a second trades can't see what you are doing easily. The HFT wins and you loose on assymetric information the HFT created. By the time you could figure anything out it is way too late.

Whether there is front running or not is moot. The point is when you create a market that encourages gaming others and using market mechanisms to offer certain people assymetric information it is inherently unfair. Furthermore if yo let people move the market before anyone can make a trade to cancel an order it is also unfair. these all are avantages program traders get over and above the natural advantages large players get simply by using their sheer size.

If people can't get a fair shake in the market they will curb their trading which hurts the market itself. The number of scandals and lower and lower real non-program trading should be sounding alarm bells all over even if the stock price is rising. The fact that it is not makes me wonder. Jush how much more beholden to program trading will the market get before everyone determines that they aren't getting a fair shake and market prices become suspect?

Jul 28 12:10 AM

[Mbuna:]

Poker players are amongst the best bald faced liars and Kid Dynamite is no exception here. Let's start with a clearly bald faced lie at the end of his article "Full disclosure: no agenda here: ..." What utter bullshit. Now if you didn't have an agenda then why did you even bother to publish this article. You have quite an agenda going here to the point that I wonder who paid you for this neat little piece of Wall St. corporate schilling. I can see from previous articles that you are in support of Goldman Sachs (check his limbs for tentacles!)

Let's take a further look at what interests Kid Dynamite- "This is the main reason I'm against most attacks on high frequency trading. SOMEONE will always be the best - the fastest - the closest - ...", "I like competition in markets." Kid is a big poker fan, traded for a hedge fund, and demonstrates the kind of narcissistic attitude that has become all to common on Wall St. these days.
Clearly the game is what matters to him and nothing else. Now picture all those firms on Wall St. filled with these types of characters, happily gaming the system to the brink of its destruction and what do you have? The recent financial history of Wall St. is what you have. Kid Dynamite along with his Wall St. brethren (and squid friends) do not have the human maturity necessary to responsibly play the games they wish to play. They need to be collared, period.

Jul 28 12:11 AM

[tgmac:]

Perception shapes expectation. Only time will tell if HFT will damage the individual investor in any appreciable manner. Given the banking debacle of 2008 with its insidiuous after effects coupled with the huge economy of scales now enjoyed by remaining banks, the HFT debate only serves to highlight how vulnerable the individual investor feels.

Many believe that the markets no longer work for the ordinary people. There is an increasing perception that a few mavens now control the markets - if by no means other than their sheer size. The individual investors feel like mere shills feeding the few who have the economy of scales and technology to control the market's destiny.

As an analogy, the remaining big banking players own the ball - lock, stock and two smoking barrels. They'll only let us play in the ball game when they know they can win.

In essence the HFT is a side show or a focus for anger for those who believe the entire financial market is being shaped for the good of the few as against the needs of the many. At a time when the individual investor needs assurance, transparency and clarity in the financial markets, HFT again clouds the overall issues confronting us.

The reality is that computers and the algorithms genereated by bankers are here to stay. Technology is now a part of the landscape. What we need is a top level inquiry about the affects and possible ramifications that this technology will have on the markets. Instead, we have inquiries sponsored by governments across the world on how best to safegaurd the banks and their position in the markets.

Personally, I still have a long term portfolio of dividend paying equities, and that's it. I don't trust short term to intermediate plays. I don't trust the commodities markets. The bond market is an utter joke. I've even come to the point of lending money over the net to generate some long term income from my capital.

When one perceives that the game is not constructed for all players on an equal basis, there is only one logical course of action for those who believe they are disadvantaged in some manner. Don't play!

Jul 28 04:24 AM

[taxed2much:]

The people here who think HFT means a guy at a computer trading in and out of different positions need some clarification. HFT means those big firms with computers the size NASA used to get men on the moon utilizing programs that can trade multiple positions on both sides of the same stock or commodity or option etc. Both short and long in a flash in order to move prices to gain a penny here and there on the bid ask spreads. The volume this creates is great for the liquidity factor but at the same time creates false price fluctuations through the fake supply and demand being created from nothing to be nothing. When firms can trade this way it is manipulation clear and simple. It is not level playing fields. Now if those firms have better computers and people manning them that place their trades instead of the computer inputting trades then that would make the playing field more palateable to traders and investors. (It would actually make investing a viable strategy again). KD certainly does have an agenda, it is to further his buddies bank accounts at GS. He probably is on the board of one of their charity foundations they create constantly in order to lobby Congress and create public awareness of something made up like global warming to further inflate their pockets at the expense of everyone else. KD thinks there is no manipulation by these computers in the bid ask spreads. If this is true then what is the problem of getting rid of them? There is no difference with them there, then there should be no difference with them gone. This of course is a ridiculous statement. We all know those computers constantly manipulate those prices and here is how I know they do. When a bid is placed on an option and the ask suddenly goes up and yet there is no more volume than when that bid was placed, that is manipulation. The bid given was the current ask, the bidder gets screwed into chasing a higher ask price if they want that option contract. The bidder can always say "screw this crap " and not play that bulsit game, but the fact is that the computer taking the orders and filling them is manipulating that price to give the owners of the exchange or firm selling that option more than what they were asking for that option when the bidder said to himself "yes, I will accept that asking price." The ask should mean the ask. It should not be allowed to raise it when there are no other bidders and you submit at the price they are asking. That is manipulation of the CBOE option computers. If KD ( or any for that matter) thinks it is fair to just operate the industry like that, then heck, why not just empty our bank accounts and send it all to GS and the other firms committing these acts of unfair and unethical market manipulations. They are going to end up with it anyway so what difference does it make? Now as for the suggestion to tax the bejeezus out of HFT in order to curb the practice. I can not disagree more. Taxes as those will only be passed along to the people who pay taxes, people pay taxes, not companies. People do, no plant, animal and no thing else but people. That aside, what good has any extra money going to any government agency ever done? I say it has done much harm and no good at all. If a tax like that does get on the books, where is the line drawn on holding time? Milliseconds, seconds, quarter minutes, half minutes, minutes, etc.? Even if the tax is only for the computers doing the actual HFT, I must point out my previous fact about who pays the tax in at the bottom line. Not anyone associated with the money generated from that HFT. NO NO NO. It is the people in the public who own shares in the funds and stocks traded by those HFT. anyone who wants to raise a tax or create a tax in order to punish is a complete fool and should take a course in finance or do some reading on how the system of money actually works.

Jul 28 04:29 AM

[mtt04:]

Does anyone remember a movie whereby the computers took over the earth because the people trusted them to do their work?

Just kidding

Seriously, anyone trying to justify a group of organizations seeing trades before they happen must be part of the Matrix or truly are blinded by greed.

The fact that a group of people can see my trade and execute before I can is plain and simple illegal. No amount of sophistry will change that.

These people broke laws I'm sure and need to be prosecuted.

Jul 28 07:37 AM

[ktchnsnk:]

as an options trader, it's hard for me to believe that somebody's not taking an unfair or illegal edge when i place a limit order at a bid or ask that's been sitting there for minutes or even longer, only see it magically vanish w/o execution, w the NEW bid or ask suddenly just beyond whatever i've just offered.

happens much too frequently to be coincidence, and it needs to be stopped.

Jul 28 09:29 AM

[Brian Grad:]

Great article. I think that one of the keys to understanding all of this is the fact that PAYMENT for order flow still exists. Maker-taker fees and rebates are the reason this exists at all. If the SEC bans this practice, much of the HFT business would dry up as it will become uneconomical to try doing "fee arbitrage".

Kid, your thoughts

Jul 28 12:44 PM

[Kinabalu:]

"People who understand equity trading know that this is just the culmination of technology advancement and competition for spreads, which has resulted in equity bid/ask spreads being narrowed to their lowest levels ever."

However there is more to market liquidity than bid-ask spreads. Liquidity also requires an orderly market. While bid-ask spreads are down the VWAP (Volume Weighted Average Price) in the last two years is far more volatile than ever. The only possible explanation for that is HFT. These programs are highly effective at finding market participants upper buy limits and lower sell limits. Speeding up that discovery process eliminates the markets historical price smoothing function.

Trading is a zero sum game. If these HFT programs are making a lot of money they are doing so at the expense of other market participants and increasing the volatility of the market at the same time. I'm not so sure that's a good thing.

Jul 28 02:11 PM

[User 155342:]

There is a problem with your Dunninger quote in that it belongs to Thomas Aquinas whose context was faith in Jesus Christ. As for frequency trading, to me it is really not a legal issue but a practical one: it will end badly as all trading schemes do. The brain's "filling in" trick (see Daniel Gilbert - Stumbling on Happiness) will always allow you to feel good about following the herd when it works, but it doesn't make the herd right. And when the herd turns up wrong (as it always does - after all you are all just herding together as opposed to understanding the forward) then you all go off the cliff together.

Jul 30 11:20 PM

[S3:]

The truth about High Frequency Trading--

www.s3.com/news2009-07...

Aug 04 03:20 PM

[marketpeon:]

Mr. Dunniger, you use a limit order in our article as an example. What about the bulk of us nobodies that place market orders. (Now you pay attention) Please explain to me how the market orders are NOT being manipulated when I place a market order for 1000 shares of Ford?

Aug 07 11:45 PM

[tickmarkt:]

its all about managing risk. Frequency has very little to do with a trade vs. the expected return vs. what you are willing to "gamble" in your bet.

Aug 11 05:28 PM

[Michael Clark:]

This should be the last word on this issue. Well reasoned comment.


On Jul 27 06:14 AM Tom Armistead wrote:

> There is ample academic evidence based on working with real data
> to demonstrate that HFT permits predatory trading on any situation
> where there is forced selling. A financial institution experiences
> liquidity problems and needs to sell concentrated positions, the
> ever vigilant algorithms pick up on it and join the selling, the
> bottom drops out until the feeding is over. Similarly if a short
> squeeze gets going the computers will exacerbate that too.
>
> To me the concern here is that the system is inherently unstable,
> particularly when many participants are highly leveraged.
>
> HFT is a manifestation of financialism: it is trading for trading's
> sake. The activity does not create any economic value for society
> as a whole, it attempts to feed at the expense of those who invest
> the fruits of thrift and industry in the real economy.
>
> As for the alleged benefits of liquidity and narrow spreads, they
> are irrelevant to those who buy when others sell and sell when others
> buy.

Aug 13 08:35 AM