A Senate panel is looking into the phenomenon of High Frequency Trading.
Here’s the infamous and hypnotic graphic from Nanex showing just how the practice has grown, showing quote volume by the hour every day since 2007 on various exchanges:
It is a relief that the issue is finally being discussed in wider venues, because we are witnessing a stunning exodus from markets as markets mutate into what we see above, a rampaging tempestuous casino of robotic arbitrageurs operating in millisecond timescales.
The conundrum is simple: how can any retail investor trust markets where billions of dollars of securities are bought and sold faster than they can click my mouse and open my browser, or pick up the phone to call their broker?
And the first day of hearings brought some thoughtful testimony.
David Lauer, who left his job at a high-frequency trading firm in Chicago last year, told a Senate panel that the ultra-fast trades that now dominate the stock market have contributed to frequent market disruptions and alienated retail investors.
“U.S. equity markets are in dire straits,” Lauer said in his written testimony.
One man who I think should be testifying in front of Congress is Charles Hugh Smith, who has made some very interesting recommendations on this topic:
Here are some common-sense rules for such a “new market”:
1. Every offer and bid will be left up for 15 minutes and cannot be withdrawn until 15 minutes has passed.
2. Every security–stock or option–must be held for a minimum of one hour.
3. Every trade must be placed by a human being.
4. No equivalent of the ES/E-Mini contract–the futures contract for the S&P 500 — will be allowed. The E-Mini contract is the favorite tool of the Federal Reserve’s proxies, the Plunge Protection Team and other offically sanctioned manipulators, as a relatively modest sum of money can buy a boatload of contracts that ramp up the market.
5. All bids, offers and trades will be transparently displayed in a form and media freely available to all traders with a standard PC and Internet connection.
6. Any violation of #3 will cause the trader and the firm he/she works for to be banned from trading on the exchange for life–one strike, you’re out.
However, I doubt that any of Smith’s suggestions will even be considered by Congress (let alone by the marketplace which seems likely to continue to gamble rampantly so long as they have a bailout line). Why? Money. Jack Reed, the Democratic Senator chairing the hearings, is funded almost solely by big banks and investment firms:
It seems more than probable that once again Congress will come down on the side of big finance, and leave retail investors out in the cold. Jack Reed opened a recent exchange on Bloomberg with these words:
Well I believe high frequency trading has provided benefits to the marketplace, to retail investors, etcetera.
Yet retail investors do not seem to agree about these supposed benefits.
Retail investors just keep pulling funds:
Reed failed to really answer this question posed by the host:
Senator, US equity markets are supposed to be a level playing field for all kinds of investors; big companies, small companies and even individuals. That said, how is it possible for an individual investor ever to compete with high frequency traders who buy and sell in milliseconds. Aren’t individuals always going to be second in line essentially to robots who can enter these orders faster than any human possibly can?
The reality is that unless regulators and markets can create an environment where individual investors can participate on a level playing field, they will look for alternative venues to put their money. It is in the market’s interest to create an environment where investors can invest on a level playing field. But I think the big banks are largely blinded by the quick and leverage-driven levitation provided by high frequency trading.
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I recently advised a Tax Return client who lost a lot of money trading Contracts For Difference. I said the “Market” is rigged. He tried justifying his losses saying he needs to do more “Education” seminars. I told him that the Computers pre-empt your trading strategies because every new day trader follows the same rules of logic regarding technical analysis. He still tried to convince me. I said be careful and wished him luck.
The only retail investors left in the market are gamblers or fools.
One benefit from high-freqeuncy trading is that commissions and fees for trades are much lower for everyone than they were previously. Also, HF trading provides great liquidity to the market, allowing for more trades to be matched, and for those trades to be matched much quicker than in the past, thus assisting in guarenteeing that the price at which you want to buy/sell will be met within seconds (assuming you’re making a reasonable bid or ask).
I agree that there can be a lot of market manipulation from these mass amounts of HF, short-term trading, but for investors who hold their positions for the long(ish) term, these short-term market fluctuations shouldn’t make much of a difference. Therefore, the “innocent” individuals investing their retirement funds in stocks aren’t really losing from the HF traders. I do think that the playing field for individual day-traders and large HF trading systems/firms is extremely unlevel. However, those individuals realize (or should realize) that they’re engaging in extremely high-risk activities, regardless if there’s HF traders potentially manipulating the market.
Sure it makes a difference. You scalp off from every trade a small amount and you end up with a much smaller pie for the rest. At a poker table, the house takes a rake every time. If you are tight as shit and don’t play that many hands, you still lose cause the money on the table is a lot less cause the house just scalped off a chunk of it over time.
Whether they lower the costs of transactions is debatable. They have a very heavy indirect costs to the market through scalped fees.
Second point is systemic vulnerabilities caused by high frequency trading. With so many orders spammed, it is impossible to control risk in the event of sudden changes. This results in flash crashes etc. Considering that the rise of HFT is relatively new yet so many problems are already popping up, how can we be so sure that greater complexity doesn’t lead to greater folly?
Isn’t that up to the exchange to control any issues such as flash crashes, and pay for any resulting customer losses? I believe NASDAQ took the heat for the one in May 2010. Also, those algo/hft firms usually pay the price themselves if their formulas are messed up (see Knight Capital last month).
I own some equities. My broker still charges too much commission. So I buy and hold.
They also cancel trades. But they are just the symptoms of the underlying rot. HFT is the cancer. These flash crashes are just symptoms.
I agree with your comments about transaction costs. But when I see advertisements about highly intelligent people using their intellect to win in the market (A complicated game of Chess or Go) and I understand the nature of advertising, then it is unethical.
Everybody is learning the same trades and computers front run them. It is blatant theft. Sure people realise it is risky and there is a disclaimer, but how many people are losing their life savings trying to “play the game”.
People should be able to trade the markets. Information changes daily and this leads to proper price discovery. What happens when the Investment Fund Manager has to automatically buy the market. Is he buying the peaks each month with everybody’s mandated savings?
I still think it’s up to the individual trying to “play the game” to know the opponents that he’s up against, and above all to know and accept the risks he/she is taking.
Regarding how an investment fund manager trades and makes decisions, that’s kind of a different topic. But in terms of how HFT affects those institutional investments, I’d say not as adversely as individual investors b/c those institutional funds get advantages via large block order execution.
Whilst I agree adults must be responsible, so too must Advertising. It must disclose all its information.
I worked briefly for a Gaming Company. Pokies (Australia) or Slot machine as US calls it. 20% is mathematically calculated to go to the house on the long run. The more you play the more you pay. Governments are limiting problem gamblers using various methods, but if you have a gambling addiction you could lose your house in a few trades. I think it needs to be regulated heavily. People think that by learning a few techniques you can trade. Trade Advertising appeals to the “Alpha” male who is smart rich successful.
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Nanex’s graphic does not show trading volume but the amount of price quotes. From the same site as the graphic: “Quote spam has exploded with no signs of stopping, while trade frequency has stalled and is actually lower than it was years ago.” [http://www.nanex.net/aqck/2804.HTML]
Indeed. Updated post to clarify that.
HFT is a excellent example of how a great deal of the dys-function in the system is perfectly legal.
The, “rule of law,” isn’t exactly what it’s cracked up to be.
The market has been historically corrupt. The wonder of it all is that it is still considered a place to ” invest”.
John: The good news is that you’ve done it again — shining light on Congressional hearings and bribe-taking, alerting the public (retail investor), and promoting more transparency. The bad news is that you’ve done it again — raised frustrating problems that have no easy fix!
I wonder what can be done to shed light on gold and silver manipulation and its (lack of) effective and honest oversight? Are markets of real assets — crude, copper, lumber, etc. — any better for having some real players, e.g., producers and refiners of crude?
What can be done is that people can stop being so %#@&! obsessed about getting something for nothing! This path leads to one result, fraud and theft, and the accompanying apologists [fraudsters and thieves] who will tell you that if we just [fill in the blank], everything will be A-OK.
Imp, old friend: Let me see if I can understand your Sep 22 reply above, so that I can consider your advice.
Pensions, insurors, retirement funds, and families (among others) need to invest their funds for security and enough growth to at least keep pace with inflation. Governments, businesses, utilities, school systems, etc. need to borrow. Farmers (sellers of grain) and bakeries (buyers) — and no doubt some middlemen as well — have a legitimate need to hedge against adverse future grain market size and price.
“Speculation” is different and presumably the object of your disaffection. Are these transactions always bad? Can they be identified and regulated? How?
Life ain’t easy or simple! But let’s hope that nations, professions, businesses and individuals will keep trying to improve through free markets and less obsessing (as you so delicately suggest).
DG, almost all of your above examples are attempts to get something for nothing. We need to get back to a time where people produced their own wealth, and lived off of their earned income and savings.
If this was the case, then there would be no need for all the financial wizardry you describe. These are simply accepted methods of stealing from other people.
Google has enabled everyone to read every language, basically. Combine that with the Internet and the global community is literally now smarter by an inordinate degree not ever before seen or even imaginable in human history.
The West is rediscovering itself, and that’s not the type of thing any person or group can place a price on – it’s invaluable.
The Empire of Reason: How Europe Imagined and America Realized the Enlightenment
Alister, more knowledge is not necessary.
Humanity has known the answers for several millennium.
Nothing is necessary! But our passions desire than simple nothingness!
A very important Heritage Foundation lecture, I think…
Once you finish your studies, come to Australia on a working holiday. It would be interesting learning from your studies and insights.
I only had to listen to 3:51 to learn that he is a reformed [fill in the blank] who now knows that what he used to believe it 100% wrong and what he believes now is 100% correct….of course, until he figures out that what he believes is 100% incorrect when he finds his new belief system….which is, of course 100% correct….
ah, typical socialist wining and hypocrisy. what are those traders gonna do now? get another job? do something else? how is it possible for a woodcutter equipped with a handaxe ever to compete with heavy machinery that cuts forest in a day? ban the machinery! ZH and others fight HFT just like labour unions fight immigrants or young people: to preserve their float of income. if HFT itself were supplying markets with healthy liquidity and capital, how would these arguments hold? and why is it suddenly so inadequate that markets became casinos? they did in 1950’s already, with a significant boost in 1971 but somehow that doesn’t seem to bother traders. actually, they love gambling with printed money accumlated within the system over decades, don’t they?
I don’t know if HFT is good or bad after all, only central planners and marxists seem to know these things ahead. but if anything is broken here, then these attempts to fix it are put in wrong place. there’s nothing wrong with investors leaving those exchanges. it is wrong that there are no exchanges where they could settle. there’s demand but no supply thanks to existing regulations.
Thanks Aziz to share some good testimonial together. Even I am not well familiar with Nanex.
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