12/5/12

According to this article, a new study by the chief economist at the Commodity Futures Trading Commission concludes that high speed trades hurt investors. Andrei Kirilenko (no relation to the basketball player) claims that high-frequency traders are "really the new middleman in exchange trading," and that the rapidly increasing speed and automation of the financial markets may pose a threat to the stability of the overall financial system. He says that the markets are a zero-sum game, where high speed profits are derived at the expense of traditional traders and investors. Some of the numbers do prove threatening:

The researchers found that more aggressive traders accounted for the largest share of trading volume and made the biggest profits. The most aggressive scored an average profit of $1.92 for every futures contract they traded with big institutional investors, and made an average $3.49 with a smaller, retail investor. Passive traders, on the other hand, saw a small loss on each contract traded with institutional investors, but they made a bigger profit against retail investors, of $5.05 a contract.

Though Kirilenko's work focused on one specific corner of the markets, regulators see high speed traders moving into a wider range of areas, including bond and foreign currency trading. The biggest investors can trade thousands of contracts at once and the average aggressive high-speed trader made a daily profit of $45,267 in a month in 2010.

Critics of Kirilenko's work claim that his research focused on profits and neglected the benefits of high speed traders, such as the lower cost of trading for regular investors. However, given limited data, it is difficult to decide whether the benefits would outweigh the costs.

What do you guys think? Based on your experience, are high speed trades hurting traditional investors?

Comments (11)

12/5/12

I could see how HFT could be hurting day traders, but I'm not sure if the argument holds up for investors -- intra-day price movements should not have an effect on longer-term horizons.

12/5/12

The only way HFT really affects 'traditional' investors is by creating a more volatile market which ends up trading on a bunch of technicals rather than worrying about fundamental strength of companies. That really is what lies at the heart of the market nowadays is a shift from fundamental qualities of companies to technical strength of markets and how you can use technicals to trade. What you run into is that the market becomes more and more unstable because if there is a large move it is exacerbated by the prevalence of machines in the market. You see it normally in large downward moves because machines, HFT guys specifically, have no repsonsibility to provide liquidity into the marketplace and if things are getting ugly they can easily just flip off the switch. Then again, so can humans.

I think the practice of quote stuffing and things of that nature are the most worrisome to me. If I can fire off thousands of bids and asks you end up with the ability to drive the price whichever way you want and move the stock around in fractions of a second. It hurts price discovery at the same time the increased liquidity in the marketplace helps it. It really is a double edged sword. Exchanges love it because the fees they are getting from HFT's are driving their revenues and earnings even when trading volumes are falling off a cliff. At some point, we might already be there, exchanges are no more than tech companies providing faster and faster access to their clients.

12/5/12

I'll let Matt Levine teach you one or two things: http://dealbreaker.com/2012/12/study-suggests-high...trading-might-costs-small-investors-almost-one-one-hundredth-of-one-percent-of-their-investments/

Best Response
12/5/12

Does automating the driving of metro trains hurt train drivers? Sure. But the net value add to anybody not a train driver is fairly high, especially in a country with an illiquid train driving labour market (read: London, Paris, etc. anywhere frequently paralyzed by bastards paid over 140k/year who want another 5% raise for accelerating and braking repeatedly)

The "traditional" market makers will bemoan the loss of an easy way to make cash. The more interesting question is: are markets more efficient as a result? Or do feedback loops screw with the pricing process, aside from the odd glitch? You will often hear an institutional complaining that these days, the price has moved 2 bucks before his trade has finished being executed, whereas in the good ol' days, he could dump 5x the amount of stock on the market with no noticeable immediate effect. Clearly this is annoying for the institutional, but is it a bad thing for everybody who wanted to buy this stock during this time frame? Is the net value add really that negative?

The problem with many changes is that the minority with the former comfortable oligopoly is small, but vocal, whilst the large number of people who are gaining a small benefit from an improvement deriving from the slaughter of aforementioned minority's privileges don't think it a sufficient reason to raise their voice (especially if they have their own oligopolies to mind).

12/5/12

EURCHF parity:
(read: London, Paris, etc. anywhere frequently paralyzed by bastards paid over 140k/year who want another 5% raise for accelerating and braking repeatedly)

Their salary is half that at the very most in Paris.

There have been a lot of studies on the costs of HFT and recent research has shown that speeds are getting so high as to impose absurd costs on the exchanges to keep up, which is probably part of the reason why the issue is getting a little more pull in political circles now. (For said research, it was featured on the trader.se, which covers the issue quite frequently). I think the current system is far better than the specialist system we had but things are being pushed too far at times.

12/5/12

GoodBread:
EURCHF parity:
(read: London, Paris, etc. anywhere frequently paralyzed by bastards paid over 140k/year who want another 5% raise for accelerating and braking repeatedly)

Their salary is half that at the very most in Paris.

London is 60k GBP, close enough in SGD (fair enough that in USD it's lower), and equivalent to a mid-level management role in a non-finance industry. Paris is 2-3k EUR a month, which for that city is "pretty good" (which says more about the French employment market) esp with 100+ "rest days" and 28 days leave. In both cases the rate is way above what it should be for unskilled labour easily automated.

12/5/12

If you are interested in HFT http://ghostexchangemovie.com/videos/ might be of interest once it comes out

12/5/12

1) HFT is basically market manipulation at its finest. You have all these programs that throw out 'fake' bids...they're fake because as soon as the market has gone up a little because of these bids, they're withdrawn before they can be scooped up. All within milliseconds. Yeah, that sounds like you're creating a ton of liquidity.

2) HFT is great because it helps to weed out all the bros who think that they can squeeze out profit from flights of emotion-driven lunacy known as technicals, headlines, obvious data releases, basically any short term market aberrations stemming from non-fundamental reasons, etc. We need more decent honest long term investors, not a bunch of button-clicking opportunists.

The strangers in this town They raise you up just to cut you down
12/5/12

I'm surprised nobody has raised this point yet:

What traditional mom and pop investor trades S&P futures contracts!?!?!?

99.99% of retail investors can't tell you the difference between algorithmic trading, high frequency trading, and electronic trading. Despite how much CNBC wants to say that HFT is why retail investors are on the sidelines, the argument is bullshit and not founded on any facts. Give me one study or any type of evidence citing how traditional retail investors are being cheated by algos.

12/5/12

I think HFT takes legitimate liquidity out of the markets, but not in the way that the CFTC's study suggests. The CFTC needs to understand that people trade because they are in the business of trying to make money. If providing liquidity were a losing proposition, the HFT shops would close up shop.

I don't think scalping is good for investors. That's not what this study seems to look at.

12/5/12
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