Reckless trading leaves legitimate investors in harm’s way

The Flashcrash of May 2010 was just a warning shot. As public markets have become the private casinos of a select few with technological weapons of mass destruction, the risk to investors and the global financial system have become overwhelming. The fact that the exchanges now make the bulk of their profits from high frequency trading, is the reason this madness continues to grow. Last week the Indian stock exchange was the latest market to “flash crash” as shown in this chart.

This is all quite simple to stop through the implementation of a financial transaction tax for minimum holding periods and a widening of the minimum bid-ask spread. Until that is done, madness and mayhem will continue to dominate. I disagree that it is just that the regulators are not vigilant enough. This is like saying that we don’t need laws that ban certain activities so long as you hire enough police and park rangers to keep an eye on things. What?

In my view this laissez faire grab-revenue-from-anywhere mentality is part of the move over the past 20 years toward legalized gambling. Most governments now collect a huge portion of their tax revenue from gambling as we all turn a blind eye to the social costs of this frequently self-destructive behavior for patrons. Condoning High Frequency Trading is actually worse than casinos, because with HFT dominated markets, it is not just those who “play” that are putting themselves at financial risk. Everyone who is trying to use public markets for investment purposes are left in harm’s way. The exchanges and prop firms are choosing to reap quick bucks with wanton disregard for the public health and security.

High Frequency Trading (HFT) deeply concerns Erik Hunsader, founder of Nanex. He worries that today’s investors, our regulators, — heck, even the HFT algorithms themselves — don’t fully understand the risks market prices face in the brave new era of bot-dominated trading.

For instance, Hunsader estimates that HFT algorithms are responsible for 70% of all completed transactions on our exchanges, and for 99.9% of all exchange quotes.

The pictures of trading floors you see on TV, where the people in bright jackets appear frantically busy in making their trades, have no bearing — claims Hunsader — on the actual trading action. The real action happens across fiber-optic cables, on racks of servers in cooled rooms; where an arms race defined by cable length and switching speeds is being waged

The reality is that the machines have taken over. When you buy or sell a security, the odds are extremely high the other side of the trade is being placed by an algorithm — one that cares nothing for the fundamentals of the underlying instrument. It simply is looking to make a quick profit, oftentimes measured in fractions of pennies. And this has vast repercussions for the stability and the fairness of our financial markets.

Because of speed advantages, HFT algos can see and react to prices faster than you can. Ridiculously faster. A second on the clock, to an HFT algo, is an eternity.

The deep pockets of the firms employing HFT algos combine with this speed to move asset prices around, sometimes wildly so, faster than most of us can comprehend. In the time it takes for your “real-time” quote system to refresh, an individual stock could have traded many percentages up and/or down — and you would have no idea.

See this clip for a good discussion of these issues. (ps. at the end of this clip he suggests individual investors can buy his trading service as a way to try and compete against the machines. I disagree with this idea of “if you can’t beat ’em join ’em” when it comes to HFT. That way lies madness.)

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2 Responses to Reckless trading leaves legitimate investors in harm’s way

  1. aliencaffeine says:

    Recently, China announced changes in how oil will be traded in the future, no longer requiring US dollars. Now there is a mess over the Senakuku Islands forcing the US to send in two nuclear-powered aircraft carrier task groups to the region. A messy situation is developing.

  2. Debman says:

    Yet another tax – no thank you.
    Recall that income tax originally applied only “to the rich”.
    Now it is really the middle class the bears the brunt of income tax.
    For the rich is merely cost of doing business.

    However, HFT bluntly externalizes costs.
    If HFT was to pay for all the non-executed trades and the micro-trades, then it would not be profitable.
    Now, it has become customary that traders do not pay for non-executed trades even though they do bear an operational cost to the exchange.
    The exchange has been making up for the non-executed trades with fees from the executed trades.
    With HFT having a disproportional ratio of non-executed trades, every request has to pay, maybe just 1c, probably a little more to represent its true cost to the exchange.
    Similarly, every micro trade must be charged equally to an HFT shop and regular traders. Micro-trades tend to be more expensive per share, which diminishes profits.

    With these two changes, which are fair in the sense that HFTs pay for their own consumption rather than externalize, I expect HFT to become less compelling.
    While I don’t care much for HFT (one way or another), I do promote it should pay for what it uses (rather than externalize).

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