High Speed Trading

High Speed Trading Said To Face N.Y Probe into fairness

New York’s top law enforcer has opened a broad investigation into whether U.S. stock exchanges and alternative venues provide high-frequency traders with improper advantages, a person with direct knowledge of the matter said.

Attorney General Eric Schneiderman is examining the sale of products and services that offer faster access to data and richer information on trades than what’s typically available to the public, according to the person. Wall Street banks and rapid-fire trading firms pay thousands of dollars a month for these services from firms including Nasdaq OMX Group Inc. and IntercontinentalExchange Group Inc.’s New York Stock Exchange.

The attorney general’s staff has discussed his concerns with executives of Nasdaq and NYSE and requested more information, said the person, who asked not to be named because the inquiry hasn’t been announced. Schneiderman’s office is also looking into private trading venues, known as dark pools, and the strategies deployed by the high-speed traders themselves.

“This new breed of predatory behavior gives a small segment of the industry an enormous advantage over all other competitors and allows them to use new technologies to reap huge profits based on unfair advantages,” according to a draft of Schneiderman’s speech to be delivered today at New York Law School. A copy was obtained by Bloomberg News.

Disrupting Strategy

The investigation threatens to disrupt a model that market regulators have openly permitted for years as high-speed trading and concerns about its influence have grown. Trading firms pay to place their systems in the same data centers as the exchanges, a practice known as co-location that lets them directly plug in their companies’ servers and shave millionths of a second off transactions. They also purchase proprietary data feeds, which are faster and more detailed than the stock-trading information available on the public ticker.

“We publicly file with the SEC for each and every one of these services, and we’re always engaged with government officials around the world,” Robert Madden, a spokesman for New York-based Nasdaq, said in a phone interview, referring to the U.S. regulator. He and Eric Ryan, a spokesman for NYSE, declined to comment on Schneiderman’s investigation.

Dark pools, including Goldman Sachs Group Inc.’s Sigma X and Credit Suisse Group AG’s Crossfinder, operate without the same regulatory oversight as the public exchanges and disclose little about their trading or the participants. Michael DuVally, a spokesman for New York-based Goldman Sachs, declined to comment, as did Drew Benson, a spokesman for Zurich-based Credit Suisse.

Mounting Concern

Special services have helped fuel high-frequency trading, in which computer programs execute orders in a fraction of a second and take advantage of fleeting discrepancies in security prices across trading venues. High-frequency activity represented more than half of all U.S. stock trading in 2012, according to Rosenblatt Securities Inc.

Critics including some regulators and market participants say that such trading, which captured the spotlight in the May 2010 flash crash in U.S. equities, serves little purpose, may distort the market and may leave retail investors at a disadvantage.

Computer-driven trades can be executed in about 300 microseconds, according to one study. At that speed more than 1,000 trades can be made in the blink of a human eye, which lasts 400 milliseconds. At their peak, algorithms shot out about 323,000 stock-trading messages each second in the U.S. last year, compared with fewer than 50,000 for the busiest period in 2007, according to data compiled by the Financial Information Forum.

Some Advantages

Andrew Brooks, head of U.S. equity trading at Baltimore, Maryland-based T. Rowe Price Group Inc., told a Senate hearing in late 2012 that the quest for speed has threatened the market.

Proponents say that high-speed trading actually increases the availability of shares in the market and that interfering with such programs would lead to higher costs and be harmful to financial stability. Indeed, the rise of computers in stock trading has helped squeeze out specialists and market makers, who had long facilitated transactions.

The current market structure, which has led to more participants, has lowered the cost of trading for investors, said Peter Nabicht, a spokesman for Modern Markets Initiative, an industry group formed last year by firms including Quantlab Financial LLC, Hudson River Trading and Global Trading Systems.

“Speed of decision-making and execution, often associated with high-frequency trading, gives traders more confidence in their interaction with the market, which allows them to efficiently make more competitive prices” and better meet investor demands, Nabicht said.

‘Tremendous Victory’

Schneiderman has previously voiced disapproval of services that cater to high-speed traders and give them a potential edge. When Business Wire, the distributor of press releases owned by Warren Buffett’s Berkshire Hathaway Inc., said last month it would stop sending the statements directly to high-frequency firms, Schneiderman called it “a tremendous victory.”

Taking his concerns public may help Schneiderman push the exchanges to alter practices, as Business Wire did, even without enforcement action. Among the powerful tools at his disposal is the Martin Act, an almost century-old law that gives him broad powers to target financial fraud in the state.

Exchanges Vulnerable

Targeting the exchanges could be the most straightforward way to deal with any ill effects of speedy trading, said James D. Cox, a securities law professor at Duke University in Durham, North Carolina.

“The exchanges are much more vulnerable to state and federal regulatory enforcement than the market participants,” Cox said. “They have a broad statute to maintain orderly markets and to do so in an ethical manner.”

The 1934 securities law that set up regulatory oversight of the U.S. financial markets specifies that exchanges enact rules to protect investors and the public’s interest, to promote equitable practices and to prevent fraud and manipulation.

Regulators have signaled concerns in recent years on how U.S equity markets operate. After the Dow Jones Industrial Average briefly lost almost 1,000 points in the flash crash, the chairman of the Securities and Exchange Commission, Mary Schapiro, said she planned to increase scrutiny of high-frequency traders.

In an effort to avoid another flash crash, the SEC worked with exchanges to create price curbs designed to prevent losses in a single stock from snowballing into a marketwide rout. The current chairman, Mary Jo White, said in January the SEC would soon publish a review of research on high-frequency trading.

Regulator’s Dilemma

Cox, the Duke professor, said New York’s attorney general is the only law enforcement body or regulator likely to target the exchanges.

“The SEC wants to protect investors, but also strengthen and promote U.S. capital markets,” Cox said. “These twin functions conflict with each other, which is why they have so far turned a blind eye on this issue.”

Some in the trading business, like Joe Saluzzi, a partner and co-head of equity trading at Themis Trading LLC in Chatham, New Jersey, have called for restraining services. Saluzzi said he’s wary of the private feeds because they’re far more detailed than public data, showing when and how a stock order was changed or canceled, which can give an insight into a particular strategy.

“Inside these data feeds is information which allows folks to read it and re-engineer the behavior of others,” Saluzzi said. “A lot of high-frequency strategies are built on modeling the behaviors of someone else.”
Price Discrepancy

The private feeds also reach traders more quickly than the public-quote system because they are sent directly from each exchange to paying customers. Public feeds build in an additional step: Price data from dozens of venues where U.S. stocks change hands are sent to a central place for processing before that information is publicized. Bloomberg LP, the parent of Bloomberg News, provides its clients with access to some proprietary exchange feeds.

A study published in January co-authored by Terrence Hendershott, associate professor of finance at the University of California, Berkeley, found the average time difference was 1.5 milliseconds between calculating a stock’s price using the exchange’s proprietary data and waiting for the public information. That’s more than enough time for a speedy trader to recognize an advantageous price and execute a trade against someone using the slower feed.

Policing Profits

The draft of Schneiderman’s speech refers to an academic paper that suggests segmenting the trading day into thousands of auctions in an effort to prevent the quickest firms from jumping ahead of others.

The paper’s co-author, Eric Budish, associate professor of economics at the University of Chicago’s Booth School of Business, told Bloomberg News in February that non-stop markets create a race between speed traders.

Operating different data feeds has led to past disciplinary action. NYSE Euronext agreed to pay the SEC $5 million in September 2012 to resolve claims it violated rules by giving some customers a head start on trading information. NYSE sent data through proprietary feeds to paying customers before relaying the same information to the public feed, regulators said. The exchange said the incident was “not from intentional wrongdoing.”

The exchanges have a variety of duties and responsibilities not just to the public, but to members and shareholders. NYSE and Nasdaq are required to police their members’ activities. In the past decade, they have moved from member-owned utilities to publicly traded companies with an eye on generating returns for shareholders.

European Crackdown

Nasdaq said in an investor presentation last week that it had close to $40 million in revenue from U.S. proprietary market data in the fourth quarter last year. The company does not reveal how much it receives from co-location of servers.

The use of high-frequency trading strategies has come under scrutiny outside the U.S.

European Parliament lawmakers reached a draft deal with national governments to curb high-frequency trading as part of tougher rules for the bloc’s financial markets, said the chief legislator working on the plans in October. The draft requires algorithms to be tested and authorized by regulators and calls for circuit breakers, among other measures.

“The negotiation team achieved a significant breakthrough on this issue,” Markus Ferber, the lawmaker leading the measures, said in an e-mail at the time. “The area of high-frequency trading is lacking suitable regulation.”

Not to deflate the highly admirable “Flash” book of Michael Lewis, but front-running on Wall Street, which is what high-frequency trading is all about and what it really intends to be, is old news. Front-running is one of the oldest tricks in the market, closely following the more notorious and widespread illicit insider trading.

What’s new is that speedy price scalping is now accomplished much faster, within nanoseconds, thanks to the latest technology and help from smart algorithm manipulations – and its continued free reign in the otherwise closely regulated industry. Where are all the market sleuths and regulators that have been so blind to what Michael Lewis has uncovered?

The flash traders aren’t in hiding. They are in fact proud of what they have been able to achieve in the stock market that has bewildered a lot of people. But who really gets hurt from such so-called high-frequency trading?

Not so much the small individual investor, to be sure. But the largest victims are the professional traders and short-term investors among the institutional investors who are major heavyweights in stock investing, and whose strategies matter most to the market. It is the insight and advanced peek into these big investors’ massive scale of buying and selling that high-frequency traders lust after as it’s pure gold to their bottom lines.

Both traders and short-term investors who invariably whirl in and out of financial securities are victimized in that they end up paying a higher price over a short window or limited time for what they buy. But for long term investors, the impact is much less and not as dramatic on their total returns since they don’t depend on quick returns.

Long-term investing has proved to be the most rewarding investment strategy, come high- or low-frequency trading. What counts the most to the long-term investors is the quality of earnings and attractive fundamentals that drive revenues and profits. In most cases, their stock portfolios spiral higher in the span of five years to 10 years, or more.

Unless the individual investors are short-term oriented or engage in market timing, the impact of the higher-frequency trades on their transactions are pretty much insignificant. And the small investors’ market behavior matters much less to the fast traders as their transactions are miniscule compared with those of the large managers of mutual funds, private and government pension funds and major activist investors.

To repeat, front-running is old hat, but what’s new is the sudden decision by government agencies such as the FBI, Securities and Exchange Commission, and the New York Attorney General to suddenly launch separate investigations to ferret out possible criminal behavior among the fast traders.

One aspect of the probe is to detefmine whether these front runners are in fact guilty of insider trading. No doubt it’s admirable that they have started to probe into fast trading and its impact and legitimacy, but one wonders where they have been all these many decades when front-running has been among the most lucrative trickeries in the market.

The paramount question is what is enabling and abetting high-frequency trading? A major source of data that the flash traders pounce on can be traced to the major stock exchanges which in fact share such proprietary material to high-frequency trading companies that aims to stay ahead of everyone else in trading securities. If that source of premium information that aren’t otherwise available to everyone else is plugged or banned, a big part of the problem would be resolved.

It’s that simple. Simply stop the exchanges from sharing and deploying such material information in violation of the privacy of investors. Clearly, if there are areas of the market that need to be urgently regulated, high-frequency trading is one of them.

So is the stock market rigged?

That’s a far-fetched assumption and difficult to prove — and a gross exaggeration. But what’s clearly visible is that most investors continue to make money from stock investing despite the market’s volatility. Over the years, investors have made tremendous retuns from the market powered by the persistent climb by the Dow Jones industrial average, S&P 500-stock index, and NASDAQ.

True, there have been all kinds of market irregularities, illegal trading and distortions, and crashes along the way. Insider trading, for one, is singularly a dark side of the market that continues to bedevil investors and the market.

But then again, if you track the market’s various major stock price charts over these many years, they have all been on the rise and climbing to new all-time highs – rigged or not.

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FBI Said To Probe High Speed Traders Over Abuse Of Information ~ Bloomberg

Federal agents are making an unusual public plea for the financial industry to bare its secrets.

The Federal Bureau of Investigation has openly solicited traders and stock-exchange workers to blow the whistle on possible front-running and manipulation via high-speed computers.

The FBI joins a roster of authorities examining high-frequency trading, in which firms typically use super-fast computers to post and cancel orders at rates measured in thousandths or even millionths of a second to capture price discrepancies. The strategy to invite whistleblowers was prompted in part by the complexity of proving any misconduct, according to a person with direct knowledge of the matter.

Whistleblowers are ready to step forward from stock exchanges, Michael Lewis, author of “Flash Boys,” said today in an interview on NBC’s Today Show. The FBI is encouraging anyone with knowledge of possible misconduct to contact them, according to an FBI spokesman.

The FBI’s inquiry stems from a multiyear crackdown on insider trading, which has led to at least 79 convictions of hedge-fund traders and others. Agents are examining, for example, whether traders abuse information to act ahead of orders by institutional investors, according to the FBI. Even trades based on computer algorithms could amount to wire fraud, securities fraud or insider trading.

New York Attorney General Eric Schneiderman opened a broad investigation into whether U.S. stock exchanges and alternative venues give such traders improper advantages.

Regulators have focused for years on whether high-speed trading hurts market stability. More recent law enforcement investigations are shifting the focus to unfair practices and possible criminal activity.

Critics including some investors and regulators have said such trading, which captured the spotlight in the May 2010 flash crash that shook U.S. equities, serves little purpose, may distort the market and may leave individual shareholders at a disadvantage.

Schneiderman is examining the sale of products and services that offer faster access to data and richer information on trades than what’s typically available to the public. Wall Street banks and rapid-fire trading firms pay thousands of dollars a month for these services from firms including Nasdaq OMX Group Inc. and IntercontinentalExchange Group Inc.’s New York Stock Exchange.

Robert Madden, a spokesman for Nasdaq, and Eric Ryan at the NYSE, declined to comment on the FBI’s inquiry. Jim Margolin, a spokesman for Manhattan U.S. Attorney Preet Bharara, declined to comment when asked if the office was looking at high-frequency trading.

The FBI began focusing on high-frequency traders last year, before Schneiderman disclosed his inquiry this month. Market regulators have asked for years whether new restrictions on rapid-fire trading were needed.

Daniel Hawke, the head of the Securities and Exchange Commission’s market-abuse unit, said in 2012 that the agency was examining practices such as co-location and rebates that exchanges pay to spur transactions. Last year, the Commodity Futures Trading Commission announced a review of speed trading and sought industry input.

Federal prosecutors have scored dozens of insider trading convictions in recent years, including several linked to SAC Capital Advisors LP, the hedge-fund firm run by Steven A. Cohen that is changing its name to Point72.

SAC agreed in November to pay a record $1.8 billion and plead guilty to securities fraud to settle allegations of insider trading. As part of the settlement, Cohen agreed to close SAC’s investment advisory business.

High frequency trading has been in the news more, thanks in part to Michael Lewis’ new book, Flash Boys. This article presents a simple explanation of how and why high frequency trading works, and why it is good for small investors.

We will begin by imagining a market with lots of small individual traders. Then we will look at how large institutional investors change the market. Next we will look at high frequency trading. Finally, we’ll explain how small investors are impacted.

Start by imagining a stock with no particular news about it. The price is stable, but there are lot of small trades. Some investors have enjoyed gains but now think the stock is overpriced. Other investors have seen gains and have decided to jump on the bandwagon. Some investors have been watching it, and now have money to invest. Others have owned it and are happy with the stock but need some cash. So lots of orders are coming in, pretty evenly mixed between buy and sell orders. The price trend for the stock looks perfectly steady.

Now consider that the traders are not all small investors. Large institutional traders are doing the same thing—some buying and some selling—but there’s a difference between them and individual investors. When a large mutual fund or pension fund places a buy order, it could be for a million shares, not a hundred shares. Similarly, sell orders from institutions come in very large quantities.

Over the course of the day, these large institutional orders cause a lumpy pattern. The chart shows what such a price line looks like. There is no noticeable trend up or down, but each institutional order moves the market up or down, and it takes a while for the price to return to the underlying trend line. That’s illustrated with the red line in the accompanying chart.

High frequency traders try to profit from the price movements caused by large institutional trades. When a mutual fund sells a million shares of a stock, the price dips—and HFTs buy on the dip, hoping to be able to sell the shares a few minutes later at the normal price. When a pension fund buys two million shares, the HFTs short-sell the stock, hoping to close their position at a profit. (Short selling is selling stock you don’t own; you borrow the shares from a stockbroker, sell them, and then later buy the stock to return the borrowed shares.)

HFTs are buying when the price is below trend and selling when the price is above trend. This tends to reduce the price fluctuations. When they are successful, prices look like the blue line on the chart. The blips are smaller and shorter-lived.

HFT is not as easy as this simple explanation sounds. First, there are many HFTs. If one is slow, the profit opportunity may have been captured by other HFTs. Second, not every blip is just a blip. If the stock is impacted by an downward trend in the overall stock market, the HFT would buy lots of different stocks—and then watch them all go down further. A good HFT has to be fast, but not so fast as to get caught be a surprise. In practice, the HFTs are no longer just looking at just one stock in isolation. They are looking at all the prices coming in, including stocks, bonds, commodities, futures and options. This massive data crunching helps them identify what are likely to be short-term blips but not long-lasting trends.

In the early days, it was fairly easy. As more companies got into the business, the easy trades were quickly taken by others. HFTs needed to move faster and faster, while crunching ever more data to avoid losing trades. Much of the attention they have received lately is due to their extreme efforts to reduce their reaction time, which is measured in milliseconds. This effort is not made to be faster than individual investors or institutional investors; HFTs are already faster than them. Instead, the effort is made to be faster than competing HFTs.

Now, how does high frequency trading impact those of us who are small investors? Look at that chart. If I place a simple buy or sell order, I may get lucky or unlucky. My buy order may be at a downward blip, but it may also be at an upward blip. I don’t want to get lucky if it means a chance of being unlucky; I’d rather trade at that underlying trend price.

Further, investors face a spread between the price at which they buy (the “ask” price) and the price at which they sell (the “bid”). This bid-ask spread compensates the market makers for executing trades at exactly the time that I want to trade. The more volatile the stock price usually is, the wider the bid-ask spread. HFTs tend to narrow the bid-ask spread by protecting the market makers from bad news while they hold their positions. Thus, my trading costs get lower.

High frequency trading is secretive and mysterious, but not at all evil. It make the stock market more efficient and helps small investors who trade at random times over the day. I could almost feel sorry for them being misunderstood—until considering that they have made far more money than I have.

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The Idiots Guide to High Frequency Trading

First, let me say what you read here is going to be wrong in several ways. HFT covers such a wide path of trading that different parties participate or are impacted in different ways. I wanted to put this out there as a starting point . Hopefully the comments will help further educate us all

1. Electronic trading is part of HFT, but not all electronic trading is high frequency trading.
Trading equities and other financial instruments has been around for a long time. it is Electronic Trading that has lead to far smaller spreads and lower actual trading costs from your broker. Very often HFT companies take credit for reducing spreads. They did not. Electronic trading did.
We all trade electronically now. It’s no big deal

2. Speed is not a problem
People like to look at the speed of trading as the problem. It is not. We have had a need for speed since the first stock quotes were communicated cross country via telegraph. The search for speed has been never ending. While i dont think co location and sub second trading adds value to the market, it does NOT create problems for the market

3. There has always been a delta in speed of trading.
From the days of the aforementioned telegraph to sub milisecond trading not everyone has traded at the same speed. You may trade stocks on a 100mbs broadband connection that is faster than your neighbors dial up connection. That delta in speed gives you faster information to news, information, research, getting quotes and getting your trades to your broker faster.
The same applies to brokers, banks and HFT. THey compete to get the fastest possible speed. Again the speed is not a problem.

4. So what has changed ? What is the problem
What has changed is this. In the past people used their speed advantages to trade their own portfolios. They knew they had an advantage with faster information or placing of trades and they used it to buy and own stocks. If only for hours. That is acceptable. The market is very darwinian. If you were able to figure out how to leverage the speed to buy and sell stocks that you took ownership of , more power to you. If you day traded in 1999 because you could see movement in stocks faster than the guy on dial up, and you made money. More power to you.

What changed is that the exchanges both delivered information faster to those who paid for the right AND ALSO gave them the ability via order types where the faster traders were guaranteed the right to jump in front of all those who were slower (Traders feel free to challenge me on this) . Not only that , they were able to use algorithms to see activity and/or directly see quotes from all those who were even milliseconds slower.

With these changes the fastest players were now able to make money simply because they were the fastest traders. They didn’t care what they traded. They realized they could make money on what is called Latency Arbitrage. You make money by being the fastest and taking advantage of slower traders.
It didn’t matter what exchanges the trades were on, or if they were across exchanges. If they were faster and were able to see or anticipate the slower trades they could profit from it.

5. This is where the problems start.

If you have the fastest access to information and the exchanges have given you incentives to jump in front of those users and make trades by paying you for any volume you create (maker/taker), then you can use that combination to make trades that you are pretty much GUARANTEED TO MAKE A PROFIT on.
So basically, the fastest players, who have spent billions of dollars in aggregate to get the fastest possible access are using that speed to jump to the front of the trading line. They get to see , either directly or algorithmically the trades that are coming in to the market.

When I say algorithmically, it means that firms are using their speed and their brainpower to take as many data points as they can use to predict what trades will happen next. This isn’t easy to do. It is very hard. It takes very smart people. If you create winning algorithms that can anticipate/predict what will happen in the next milliseconds in markets/equities, you will make millions of dollars a year. (Note:not all algorithms are bad. Algorithms are just functions. What matters is what their intent is and how they are used)

These algorithms take any number of data points to direct where and what to buy and sell and they do it as quickly as they can. Speed of processing is also an issue. To the point that there are specialty CPUs being used to process instruction sets. In simple terms, as fast as we possibly can, if we think this is going to happen, then do that.

The output of the algorithms , the This Then That creates the trade (again this is a simplification, im open to better examples) which creates a profit of some relatively small amount. When you do this millions of times a day, that totals up to real money . IMHO, this is the definition of High Frequency Trading. Taking advantage of an advantage in speed and algorithmic processing to jump in front of trades from slower market participants to create small guaranteed wins millions of times a day. A High Frequency of Trades is required to make money.

There in lies the problem. This is where the game is rigged.

If you know that by getting to the front of the line you are able to see or anticipate some material number of the trades that are about to happen, you are GUARANTEED to make a profit. What is the definition of a rigged market ? When you are guaranteed to make a profit. In casino terms, the trader who owns the front of the line is the house. The house always wins.

So when Michael Lewis and others talk about the stock market being rigged, this is what they are talking about. You can’t say the ENTIRE stock market is rigged, but you can say that for those equities/indexs where HFT plays, the game is rigged so that the fastest,smart players are guaranteed to make money.

6. Is this bad for individual investors ?
If you buy and sell stocks, why should you care if someone takes advantage of their investment in speed to make a few pennies from you ? You decide, but here is what you need to know:
a. Billions of dollars has been spent to get to the front of the line. All of those traders who invested in speed and expensive algorithm writers need to get a return on their investment. They do so by jumping in front of your trade and scalping just a little bit. What would happen if they weren’t there ? There is a good chance that whatever profit they made by jumping in front of your trade would go to you or your broker/banker.
b. If you trade in small stocks, this doesn’t impact small stock trades. HFT doesn’t deal with low volume stocks. By definition they need to do a High Frequency of Trades. If the stocks you buy or sell don’t have volume (i dont know what the minimum amount of volume is), then they aren’t messing with your stocks
c. Is this a problem of ethics to you and other investors ? If you believe that investors will turn away from the market because they feel that it is ethically wrong for any part of the market to offer a select few participants a guaranteed way to make money, then it could create significant out flows of investors cash which could impact your net worth. IMHO, this is why Schwab and other brokers that deal with retail investors are concerned. They could lose customers who think Schwab, etc can’t keep up with other brokers or are not routing their orders as efficiently as others.

7. Are There Systemic Risks That Result From All of This.
The simple answer is that I personally believe that without question the answer is YES. Why ?

If you know that a game is rigged AND that it is LEGAL to participate in this rigged game, would you do everything possible to participate if you could ?

Of course you would. But this isn’t a new phenomena. The battle to capture all of this guaranteed money has been going on for several years now. And what has happened is very darwinian. The smarter players have risen to the top. They are capturing much of the loot. It truly is an arms race. More speed gives you more slots at the front of the lines. So more money is being spent on speed.

Money is also being spent on algorithms. You need the best and brightest in order to write algorithms that make you money. You also need to know how to influence markets in order to give your algorithms the best chance to succeed. There is a problem in the markets known as quote stuffing. This is where HFT create quotes that are supposed to trick other algorithms , traders, investors into believing their is a true order available to be hit. In reality those are not real orders. They are decoys. Rather than letting anyone hit the order, because they are faster than everyone else, they can see your intent to hit the order or your reaction either directly or algorithmically to the quote and take action. And not only that, it creates such a huge volume of information flow that it makes it more expensive for everyone else to process that information, which in turn slows them down and puts them further at a disadvantage.

IMHO, this isn’t fair. It isn’t a real intent. At it’s heart it is a FRAUD ON THE MARKET. There was never an intent to execute a trade. It is there merely to deceive.

But Order Stuffing is not the only problem.

Everyone in the HFT business wants to get to the front of the line. THey want that guaranteed money. In order to get there HFT not only uses speed, but they use algorithms and other tools (feel free to provide more info here HFT folks) to try to influence other algorithms. It takes a certain amount of arrogance to be good at HFT. If you think you can out think other HFT firms you are going to try to trick them into taking actions that cause their algorithms to not trade or to make bad trades. It’s analogous to great poker players vs the rest of us.

What we don’t know is just how far afield HFT firms and their algorithms will go to get to the front of the line. There is a moral hazard involved. Will they take risks knowing that if they fail they may lose their money but the results could also have systemic implications ?. We saw what happened with the Flash Crash. Is there any way we can prevent the same thing from happening again ? I don’t think so. Is it possible that something far worse could happen ? I have no idea. And neither does anyone else

It is this lack of ability to quantify risks that creates a huge cost for all of us. Warren Buffet called derivatives weapons of mass destruction because he had and has no idea what the potential negative impact of a bad actor could be. The same problem applies with HFT. How do we pay for that risk ? And when ?

When you have HFT algorithms fighting to get to the front of the line to get that guaranteed money , who knows to what extent they will take risks and what they impact will be not only on our US Equities Markets, but also currencies, foreign markets and ? ? ?

What about what HFT players are doing right now outside of US markets ? All markets are correlated at some level. Problems outside the US could create huge problems for us here.

IMHO, there are real systemic issues at play.

8. So Why are some of the Big Banks and Funds not screaming bloody murder ?
To use a black jack analogy , its because they know how to count cards. They have the resources to figure out how to match the fastest HFT firms in their trading speeds. They can afford to buy the speed or they can partner with those that can. They also have the brainpower to figure out generically how the algorithms work and where they are scalping their profits. By knowing this they can avoid it. And because they have the brain power to figure this out, they can actually use HFT to their advantage from time to time. Where they can see HFT at work, they can feed them trades which provides some real liquidity as opposed to volume.

The next point of course is that if the big guys can do it , and the little guys can let the big guys manage their money , shouldn’t we all just shut up and work with them ? Of course not. We shouldn’t have to invest with only the biggest firms to avoid some of the risks of HFT. We should be able to make our decisions as investors to work with those that give us the best support in making investments. Not those who have the best solution to outsmarting HFT.

But more importantly, even the biggest and smartest of traders , those who can see and anticipate the HFT firms actions can’t account for the actions of bad actors. They can’t keep up with the arms race to get to the front of the line. Its not their core competency. It is a problem for them, but they also know that by being able to deal with it better than their peers, it gives them a selling advantage. “We can deal with HFT no problem”. So they aren’t screaming bloody murder.

9. So My Conclusion ?
IMHO, it’s not worth the risk. I know why there is HFT. I just don’t see why we let it continue. It adds no value. But if it does continue, then we should require that all ALGORITHMIC players to register their Algorithms. While I’m not a fan of the SEC, they do have smart players at their market structure group. (the value of going to SEC Speaks . While having copies of the algorithms locked up at the SEC wont prevent a market collapse/meltdown, at least we can reverse engineer it if it happens.

I know this sounds stupid on its face. Reverse engineer a collapse ? But that may be a better solution than expecting the SEC to figure out how to regulate and pre empt a market crash

10…FINAL FINAL THOUGHTS
i wrote this in about 2 hours. Not because i thought it would be definitive or correct. I expect to get ABSOLUTELY CRUSHED on many points here. But there is so little knowledge and understanding of what is going on with HFT, that I believed that someone needed to start the conversation

The Problem of HFT - Collected Writings on High Frequency Trading & Stock Market Structure Reform : Haim Bodek

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This book explores the problem of high frequency trading (HFT) as well as the need for US stock market reform. This collection of previously published and unpublished materials includes the following articles and white papers:

1. The Problem of HFT - explains how HFTs came to dominate US equity markets by exploiting artificial advantages introduced by electronic exchanges that catered to HFT strategies

2. HFT Scalping Strategies - describes the primary features of modern HFT strategies currently active in US equities as well as the benefits these strategies extract from the maker-taker market model and the regulatory framework of the national market system

3. Why HFTs Have an Advantage - explains the critical importance of HFT-oriented special order types and exchange order matching engine practices in the operation of modern HFT strategies

4. HFT - A Systemic Issue - a discussion of the latest industry and regulatory developments with regard to exchange order matching practices that serve to advantage HFTs over the public customer

5. Electronic Liquidity Strategy - proposes a conceptual framework for institutional traders to achieve superior execution performance in HFT-oriented electronic market venues

6. Reforming the National Market System - proposes a 10-step plan for strengthening the operation of the US equities marketplace in order to serve the needs of long-term investors

7. NZZ Interview with Haim Bodek - addresses current topics and proposals for US equities market structure reforms

8. TradeTech Interview with Haim Bodek - addresses the current status of the HFT special order type debate

Wall Street: The speed traders

High frequency trading has roiled the stock and bond markets. The machines have taken over, and they can do far more business than a human can. But HFT has plenty of risk attached, as this short video explains.

Sean Gourley – High frequency trading and the new algorithmic ecosystem

Money & Speed: Inside the Black Box (Marije Meerman, VPRO)

Money & Speed: Inside the Black Box is a thriller based on actual events that takes you to the heart of our automated world. Based on interviews with those directly involved and data visualizations up to the millisecond, it reconstructs the flash crash of May 6th 2010: the fastest and deepest U.S. stock market plunge ever.

Money & Speed: Inside the Black Box is developed by filmmaker Marije Meerman in close collaboration with design studio Catalogtree. This explorative documentary is a marriage of strong storytelling and meticulous visual analysis. A rare opportunity to experience what is happening inside the black boxes of our rapidly evolving financial markets.