The big debate within Wall Street now is not over huge bonuses but instead over high frequency trading and flash orders. The issues surrounding HFT are complicated and require a careful balance to be struck between the need for continued innovation, liquidity as well as price improvement and on the other hand, equality, transparency and prevention of system wide risks.The issue is complex but it can be boiled down to one question: is the exchange ensuring that every single participant has equal opportunity and access to the same information?
I stopped watching CNBC years ago but every once in a while friends send me a link to one of their online videos like this recent one about high frequency trading and I’m reminded all over again why I don’t watch CNBC:
This is exactly what is wrong with CNBC. They spend more time designing and perfecting their chyrons and the makeup and hair of their hosts and seemingly none at all actually researching or understanding an issue. You know, that thing we used to called journalism. In the end what could be an enlightening and intelligent dialogue about an advanced function of the financial markets deteriorates into childish ad hominems.
The debate over high frequency trading reminds me of the controversy a few years ago when large institutions were able to transact in mutual funds units after the close. By getting yesterday’s price, that is buying after knowing the market close, they made millions of dollars. Until they were stopped.
Flash orders, per se, are not evil. Actually, they are quite useful and regularly allow large traders to get better prices than they would normally get. Here is a diagram illustrating how they work. The problem is that we now have opportunistic computer algorithms which out-trade the slower and larger institutional traders. And this segment of the exchange volume has exploded in recent years. The exchanges love it because it increases their volume traded and they get paid co-location fees for housing the computers that power the myriad instantaneous trades.
So it isn’t difficult to see the dilemma. It is the same one that faced the SEC recently when they looked at the regulations surrounding short sales. Finally, the SEC moved to fix naked shorting, a big problem. Hopefully the rest of their regulatory modifications will be the scalpel type - not sledgehammer swings.
Here are a few recently articles which explore the issue of high frequency trading:
- How to Understand High Frequency Trading
- Stock Traders Find Speed Pays, in Milliseconds
- We Fear What We Do Not Understand
- Demystifying High Frequency Trading
- High-Frequency Traders Say Speed Works for Everyone
- SEC Pressured to stop HFT
You can find many others at news.tradersnarrative.com (check in as interesting links are added regularly).
Here’s a short video discussing high frequency trading and flash orders, which is refreshingly nothing like the CNBC clip mentioned above:
Tabb is a contributing editor at Advanced Trading magazine and because of his day job, he comes at this issue with his own biases. Although the interview isn’t as polished and has lower production qualities, it is still infinitely more rewarding listening to Tabb than to the screechings from CNBC.
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