Mr. Lewis caused a huge bunch of focus to be placed on his book when he stated on air that, “Wall Street is rigged.” That bothered me greatly as I was sure that such a phrase would be flying across the headlines—it was. I was also concerned that many investors would become all that more certain that they have been taken advantage of by this so-called rigged system—and some were.
That’s because ordinary people are.
My mission here is to help you to cut through the noise and help you better understand what this HFT is. In addition, I want to dispel any feelings you may have that you’re in a rigged scam when you invest. You’re not.
Michael continues on with the shibboleth about specialists on the exchange and how we traded in 1/8th (and then 1/16th) of the dollar. All true. I traded in those days. But he conveniently forgets a few facts along the way.
- The Specialists, in exchange for the privilege of the spread, had an obligation to take the other side of your trade when nobody else wanted it. Today that so-called “obligation” doesn’t exist. The result is events like the flash crash, where the bid just plain old-fashioneddisappears. There are dozens of these on an average day in individual issues now, where before there were none. You may argue that this doesn’t hurt you, but you’ll have to find some evidence for that first, and there isn’t any.
- Speed makes human analysis impossible at a certain level. How do you wind up with stocks that trade at 1,000x nearly-non-existent earnings? With what justification do moves of 5, 10, 20, 30% in fractions of a second occur? Not to put too fine a point on it bubbles require gullible suckers who will line up and bid up asset prices on vapor. Or, if you prefer, price justifies price. Well, for a while anyway. The old chestnut about markets being a balancing act of greed and fear is true. Speed is the enemy of contemplation. So why is it that we’re focused on speed rather than contemplation?
- Reg-NMS mandates that all market participants have access to the National best bid and offer. HFT is nothing more than an end-run around this regulation which is supposed to have the force of law. Michael wishes to claim that HFT is some sort of “public good” that came out of Reg-NMS, which itself was put through to address the gaming of the markets during the 1990s, largely (but not exclusively) through SOES. But HFT is nothing more than an evasion of Reg-NMS in that “private” feeds that are faster than the consolidated feed are supposed to be barred by Reg-NMS — yet without them HFT cannot turn a profit!
Finally, Michael tries to run this load of nonsense:
The high-frequency traders do make money from investors, but they do so just by being on the right side of the trade. If an HFT firm simply fills every single investor order at the best price in the market, then over the course of a day, and certainly over the course of a year, it’ll make a decent profit.
Except that’s not what they do.
By colocating machines and obtaining private feeds that are faster than the consolidated tape HFT violates the spirit and, I’d argue, the law when it comes to Reg-NMS. By issuing quotes, whether to buy or sell, that are intended not to execute but rather to dupe other traders (whether computers or humans) into exposing their intentions in the marketplace HFT violates The Securities and Exchange Act as well.
I have no quarrel with computers executing trades. But the clear intention of Reg-NMS, and that of regulations before and after it going all the way back to The Securities and Exchange Act is to promote a level playing field in the public markets.
That is, you may only put forward a bid or offer if you intend to have it execute. Further, you may only put forward such a bid or offer such thatall participants in the market can hit said bid or offer, not just certain participants.
The current HFT paradigm makes a mockery of both of these founding requirements behind any fair, public market. It is not hard to fix these issues either, but Michael doesn’t want to talk about that and neither do the rest of the HFT boosters, because as soon as you fix them the “business model” of HFT, which is inherently about finding ways to pick someone’s pocket for a fraction of a cent on each transaction, disappears.
Simply put we could solve all of the HFT problems with a few very small changes, specifically:
- Prohibit the cancellation of an order until either (1) 2 seconds have elapsed or (2) it has executed, whichever comes first. That is, you must expose your order to all market participants on this big blue ball called “Earth” no matter where they are and the reaction time of said participant along with the physics involved in the delay of reacting to your bid or offer must be respected. This is the premise of Reg-NMSand we should enforce it.
- Prohibit the provision of any data feed that results in the delivery of information at a rate exceeding, or with a time delay of less, than the consolidated tape, with fines of the total amount of all bids and offers presented in advance for violators. That would make the penalty so severe that this sort of cheating will simply never happen. In short if you’re going to mandate that everyone have equal access thenenforce it.
- Prohibit the provision of any bid or offer unless the party issuing same can clear, in total, all outstanding bids and offers attributed to them at any instant in time. Ordinary traders and investors have always been bound by this restriction. If the initial margin for a futures trade is $5,000 per contract and I have only $6,000 in cash in my account I cannot put up two bids to buy one contract each, as I can only clear one of the trades. There is no legal dodge available to allow me to do so either; The Securities and Exchange Act says that any order that I issue for any purpose other than executing said order (that is, where my intent is to move a price or represent an interest in a security is false) is illegal. It is therefore obvious that if I issue two bids but can only clear one I am by definition breaking the law because I am representing an interest in a security that I cannot actually purchase!
That’s it. Do those three things and if HFT can survive in a world where the actual law is respected I have no problem with it.
The HFT people, of course, will have lots of problems with these three changes, because if we were to actually enforce both The Securities and Exchange Act along with Reg-NMS I argue that it is impossible for them to make money.
If Michael wishes to argue otherwise then let’s enforce the law and find out who’s right.
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