Where Is My Buggy Whip?

Jeff  Carter
Posted: Aug 08, 2012 12:01 AM

If you read this blog regularly, you will see some blog posts devoted to high frequency trading(HFT). If you skim them, you will be left with the impression that I am against all electronic trading in the market and especially against HFT.

What’s interesting is that whenever someone in the trading community advocates against HFT, they are immediately characterized as being a member of the flat earth society. Instead of critically assessing the foibles of the current way the marketplace is structured, the advocates for HFT try and tear down the reputations of their critics. It’s bullshit and they know it.

There have been so many market disruptions across the board from electronic trading and/or from HFT that long time market watchers with a lot of experience know something is amiss. Jack Bogle was on CNBC yesterday citing HFT for a lot of the problems in the current market place. If there is a person that should be neutral to HFT, it would be a person like Bogle, who’s Vangard fund famously follows the precepts outlined in Eugene Fama’s Efficient Market Hypothesis.

Weekly, somewhere, some EFT or some stock or future has a flash crash or flash rally. The problem with electronic trading is that markets are so interconnected and algos read so many correlations that you never know which mini crash is going to be the domino that sets the whole thing on fire. This isn’t confined to geographical borders, because what happens in Asia and Europe has a direct statistical effect on what happens in the US. When the US market crapped out in May of 2010, the futures prices for other markets declined as well.

There is no way to untie the capital correlations across borders, and there isn’t a way to have the exact same regulation. It is impossible to have one international sovereign body that oversees all markets because of international competition. Who wants to give up local control of their market system? Additionally, we cannot tax our way out of the problem. Tobin or transaction taxes won’t do a thing to fix what is wrong. All they will do is add costs.

First, I would love to see someone in from the HFT industry call out the bad actors. There isn’t a publicized set of industry standards that HFT people adhere to. When the futures industry had a horrible reputation back in the late 1950's early 1906's, people from inside the futures industry did something about it. The best way to affect change is through local peer pressure.

Every futures pit on a trading floor had a different culture. The culture of the hog pit was similar, yet different than the culture of the cattle pit-even though they both traded livestock. Traders called out each other and put to rest sketchy practices. Your word was your bond. The CME had a different culture than the CBOT, even though they were both in Chicago and traded futures. Exchanges disciplined their members, and threw them out if necessary banning them from conducting business. Right now, HFT has a shitty culture.

One of the ways to correct the current problems in the industry is through changing the market structure. Payment for order flow is one variable that should be ended. Internalization of order flow is another. Each changes the risk profile of trading. Dark pools that aren’t accessible to the public are an outright ink blot on the idea of free markets. They should be banned.

In the age of electronics and internet, we ought to be flattening out distribution systems. Instead, banks are using regulators to codify tiered distribution to protect their profitability. I don’t see any of the HFT guys yelling about that since they are beneficiaries of the flawed system.

Because of the speed, HFT trading algos take very little risk, yet reap gigantic rewards. Not only that, in many cases they can see “the book” before the rest of the market, giving them a huge edge. Because exchanges ($CME, $ICE, $NYX, $NDAQ) sell them data, they have more information than the market, allowing them to press and influence markets in ways that traders only used to dream of, with no regard for ethics or market integrity.

Not all HFT shops are this way. My gut tells me that like old human traders, it’s a few bad apples spoiling the entire bunch. My suggestion is that they get their own house in order before someone else does. When someone else cleans your house, they don’t do as good a job as you can.

Instead, when old pros like myself point out flaws in the system, they say we want to embrace buggy whips. The reality is good old traders know they can compete. They just want a level playing field. Speed doesn’t scare us. Old traders are used to speed and markets gyrating. The thing that pisses them off is they know that by regulatory fiat, and through exchange policy, they are starting that race ten yards behind.

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