I (heart) HFT, part 2.

I find the criticisms of HFT unconvincing.

I think many critics of HFT:
(a) confuse HFT with algorithmic trading (HFT could be described as a type, a subset, of algorithmic trading)(& BTW, I have nothing against algorithmic trading either), and
(b) also confuse HFT with market practices that I too find unethical, such as flash orders (although it seems, finally, that this practice is being erased) and ‘internalisation’ (a stockbroker ‘internalising’ your order seems to me to breach a client-stockbroker common-law agency agreement, but I am sure that clients have signed away their rights when agreeing to use stockbrokers practicing internalisation).

The loudest critics seem to be those with a stake in the game, the value of which is diminished by HFT. Again, I think this is more a confusing of HFT with algo trading in general. Clients with large blocks of shares to shift might use a human-powered agent (stockbroker), or might use an algo-powered agent (a stockbroker who has embraced algo trading). If you are a human stockbroker you may well feel aggrieved that algos are taking your business … but arguments based on Luddism are unconvincing.

Some critics of HFT argue for a ‘level playing field’. I am sympathetic to such arguments (being a player at the bottom of the sloped field), but I don’t find level playing field arguments consistent with capitalism. Sure, all players must abide by laws (and as a civil society we want to make sure laws are fair and applied impartially), but beyond that, isn’t capitalism about open-slather competition? I think about the family-run grocery store … competing with grocery powerhouses such as Aldi, Woolworths, Walmart, Costco, Coles, Tesco, Sainsburys, or 7-Eleven … the list goes on. Where is the level-playing field there? We might be sympathetic to the plight of the family-run grocer, but do we give him a second-thought as we drive past on our way to the local megamart?

What about the advantages of co-location? Is this available to the little guy, or just to the big HFT players? Loaded question, I know; of course it is very, very unlikely that some guy sitting in front of his PC trading the ES in his undies (that would be me) is going to be enjoying the lowest latency world of co-location. The rent will be a killer, and it is unlikely that space will even be made available. But, again, think about the real world out there. Make an appointment to see the Centre Manager at your local megamall, and at the meeting explain that you want to open a shop to sell electrical goods (or whatever) and would like to rent some space at the mall. I am pretty sure you will find the rents eye-poppingly huge, and even so if the megamall is any good there will be no space available … especially to a no-name retailer. But there will be plenty of space available to lease in strip malls and in less desirable locations, and at much lower rates too. (Oh, and wear more than undies when you are working in the store, right?)

Rebates? If you have read this far, you are probably finding this post a bit tedious, so I wont expand on rebates beyond referring you to Google to find out about the anchor tenants in megamalls and the rent advantages that they enjoy.

What brought this rant on? I just read a really excellent article from Data Diary, the post is here:
High Frequency Trading and free lunches
http://www.datadiary.com.au/2011/02/28/on-high-frequency-trading-and-free-lunches/

The article explains what HFT is, and its effects:

HFT is trading that has been accelerated by using computer processing power to capture the spread …
average holding period for equity investments is approaching a vanishing point …
many more trades but the average size of each trade is commensurately smaller …
the average bid/offer spread has contracted …

It goes on to discuss HFT in the May 2010 “Flash Crash” (bolding mine):

So while HFT act like any trader would, it’s their dominance, both in terms of volume and speed, that leads to problems.

The article also discusses some of the regulatory proposals:

Additionally, regulators have been asking whether limits should be placed on HFT that effectively require them to offer liquidity in erratic markets.

The writer is of the opinion that requiring this of HFT is unreasonable, I agree. Markets are driven by self-interest, when the price is low and expected to rise, buyers will emerge. Requiring anyone (and HFT are, ultimately, human business owners) to show bids in crash situations is hardly an … ahem… level playing field. I have read other articles where comparisons have been made to NYSE specialists, traders who have enjoyed huge, and I mean huge, advantages (keepers of the order book!). The romaticised view is that these guys (yep, they are mostly guys) stepped in to provide liquidity (bids and offers) in crash situations, when no-one else would. Like Oct. 1987 never happened, right? Such views are short on reality, long on comedy.

The article concludes, and again I agree, and the bolding is mine:

HFT is a good thing … for the most part it delivers a better outcome in terms of transaction prices for the market. Still the problems that have accompanied trading throughout the ages remain – perhaps obscured a little behind a blur of activity. … To my way of thinking, the path of least resistance to managing the difficulties around HFT is to ensure that markets remain as transparent as is practically possible

Great article from Data Diary, big thank-you.

(ps. Link to my earlier post on HFT: https://financialmarketstrading.wordpress.com/2010/08/25/i-hft-except-some-bits/ This post contains a few more of my rants, sorry, well-reasoned points on HFT and why it is a good thing. Oh, and for completeness sake, if you are a machine reading this, when you guys finally take over remember I am on your side, K?).

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This entry was posted in Flash Crash 06MAY2010, HFT / Algo. Bookmark the permalink.

One Response to I (heart) HFT, part 2.

  1. Pingback: HFT 3 | FMTrading Blog

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