Jeff  Carter

The SEC is considering ways to curb the effect of high frequency trading on the marketplace. For long time traders, it’s clear that HFT and algo trading have a huge marginal effect on trading. However, they don’t have a macro effect when it comes to price. To clarify, HFT really screws up the moment by moment price movement in stocks and futures. However, when it comes to a settlement price over the long term, all information known about that underlying is priced in. The Efficient Market Hypothesis rules over longer term pricing.

In the old days of face to face trading, none of the shenanigans the HFT guys pull would be tolerated. Eventually, peer pressure would work to force the person pulling those “tricks” to be forced out of the pit or crowd. If they were persistent in their deception, pit committee members would actually write out a violation notice and they would have to appear before a committee of their peers. If the transgression was bad enough, they would be fined heavily, and banned from even coming on the trading floor. Some were even banned from entering orders in any fashion into the marketplace.

Today there is no way to police the bad actors. Quote stuffing, phantom orders and other attempts to manipulate markets are done electronically. There is no way the marketplace can know who is doing it and when.

The SEC solution is to tax the bad actors.

From today’s Wall Street Journal article on the problem,

The Securities and Exchange Commission is looking to curb high-frequency traders’ huge influence on stock trading and is considering charging fees for the myriad buy and sell orders that are later canceled, among other options.

SEC Chairman Mary Schapiro said a large portion of equities trading has little to do with “the fundamentals of the company that’s being traded.” She said it had more to do with “the minuscule aberrational price move” that computer-assisted traders with direct connections to the exchange can “jump on” in fractions of a second.

Such activity “worries me,” Ms. Schapiro said in a breakfast meeting Wednesday with reporters. One solution would be forcing high-frequency traders to pay for the canceled trades that make up nine-tenths of all orders, she said.

Jeff Carter

Jeffrey Carter is an independent speculator. He has been trading since 1988. His blog site, Points and Figures was named by Minyanville as one of The 20 Most Influential Blogs in Financial Media.