SEC Concerned About High Frequency Trading

Wall Street

from the so-what-do-you-do-about-it? dept

Wed, Jan 13th 2010 5:30pm — Mike Masnick

Back in December, we had an interesting discussion on high frequency trading and whether or not it was just (as its supporters' claim) "adding liquidity to the market to make it more efficient or whether it was a dangerous arbitrage bubble based on questionable practices that put the whole system at risk (or, of course, somewhere in between). The general consensus appeared to be that high frequency trading was pretty bad -- and even if you believed that it had some useful applications, the fact that it has come to so dominate the market was not a good thing. The key point was that it wasn't generating money by doing anything useful, but just from moving money around faster than someone else. Overall, there was definitely a concern about the practice.

It appears the SEC shares your concern, and has voted to do something about it. The real question, though, is what are they going to do -- and will it help or will it actually make things worse? It looks like the suggested changes just involve trying to make the brokerages more liable for actions done by unregulated clients using the brokerage's access to exchanges. The idea is that the brokerages would then force partners to crack down on really risky behavior. While I understand the logic, it worries me. It seems like the opposite of safe harbor type laws on the internet, and would, in fact, make "service providers" more liable for actions of third parties. That always seems like the wrong approach. It's outsourcing policing and risk management and hoping that by adding liability the service provider will do a good job of it. But what if the service provider can't do that well? And what if the third party screws up anyway? Does it make sense to put blame on someone who is effectively a middleman?

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Filed Under: bubbles, efficiency, high frequency trading, liquidity
Companies: sec

25 Comments

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Andrew F (profile), 13 Jan 2010 @ 5:49pm

What would happen if we just introduced a transaction tax?
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:), 13 Jan 2010 @ 5:56pm

Don't see it working.
Third parties will just make fronts out of the middleman and will not worry about.
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fishbane, 13 Jan 2010 @ 6:21pm

Re:
That would be the best thing, if the goal were to actually attempt to squelch, to some degree, the practice. But you're forgetting who owns the government.

The goal is actually to look like something is being done without actually inconveniencing the bankers.
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:Lobo Santo (profile), 13 Jan 2010 @ 6:31pm

Re: Re:
Correct! A gold star for fishbane!!
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PhilD, 13 Jan 2010 @ 7:01pm

Re:
There used to be a transaction tax, it was rescinded because it generated "too much money".

If there was EVER a tax I would support it would be a tax on this.
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jim aldworth (profile), 13 Jan 2010 @ 7:20pm

By putting the liability on the brokerage house it will force them to be more selective about the clients they take on. All users of a brokers high frequency platform are vetted before they are brought on board, and continuously monitored to make sure they are in compliance with all regulations. If a broker is breaching the rules because of an end user, they will change the way that end user trades, or drop them from the platform.
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Chargone (profile), 13 Jan 2010 @ 7:49pm

Re: Re:
wait... they dumped a tax because it was actually allowing them to function?

what?
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vastrightwing, 13 Jan 2010 @ 8:19pm

Goldman Sachs again
We have Goldman Sachs to thank for this. They have led the way on this. Surprised? Personally, I don't know how you can prevent or regulate high frequency trading: who's to say what that means exactly. This is no different than allowing trading of oil and commodities without taking delivery. That is, it just inflates the price and adds no value. Since Goldman alumni are all over government, it's unlikely to see this end anytime soon.
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PrometheeFeu (profile), 13 Jan 2010 @ 10:30pm

What I really want to see regulated is flash trading. That is effectively insider trading. I still don't understand how it could possibly be even considered for a split second to be legal.
High frequency trading I think is unlikely to be that big of a deal. Positions are held for a very short amount of time and so most likely it just amplifies very short-run fluctuations without contributing to medium-term prices.
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Michael Kohne, 14 Jan 2010 @ 4:24am

HFT...
It's quite the lie to say that HFT provides liquidity - the only things these guys trade are things that are already moving at high speeds.

All that HFT does is to line the trader's pockets. Just like anything else where the trader buys with regard only to market trends.

That said, I don't think there's much that can be done without significantly changing the operation of the markets themselves. Which might not be a bad idea, but isn't really what the SEC is looking at.
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Anonymous Coward, 14 Jan 2010 @ 5:25am

I'll see your megahertz and raise a gigahertz
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Steve R. (profile), 14 Jan 2010 @ 5:32am

Predictive Models
It is my understanding that one of the controversial aspects of HFT is that the underlying computer programs are sophisticated and powerful enough to the point of being able to "read" (project) the market as it moves and to insert trades into that movement.

From the point of nifty powerful technological sophistication, there is nothing wrong with HFT. But from the viewpoint of an open (transparent) and fair market operation based on everyone being able to observe the bidding process and make an informed trading decision, it would seem to be quite unfair.
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GeneralEmergency (profile), 14 Jan 2010 @ 6:06am

Minimum hold time?
Why not just make it illegal to trade a share until you have owned it for 6, 12 or 24 hours?
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EH, 14 Jan 2010 @ 6:56am

Re: Minimum hold time?
> Why not just make it illegal to trade a share until you have owned it for 6, 12 or 24 hours?

Well, mainly because the goal is not to completely destroy the stock market and dismantle the economy. But if that's what you were after, that'd be a good start on how to do it.
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GeneralEmergency (profile), 14 Jan 2010 @ 9:14am

Re: Re: Minimum hold time?
How would such a requirement destroy the stock market?

Isn't the purpose of the stock market to provide a means for investing in publicly held companies?

HFT is simply not "investing" by any stretch of the imagination. It is gaming the system, pure and simple.
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EH, 14 Jan 2010 @ 10:32am

Re: Re: Re: Minimum hold time?
Because nobody will invest if there is such a ridiculous requirement. What if you buy a stock, then news comes out and you want to unload it? Plus, if there is no liquidity (which there wouldn't be), the prices would fluctuate wildly. Additionally, the entire market structure would have to be torn out and regenerated, as certain entities are required to be on both the buy side and the sell side at all times. So that'd be right out as well. In short, even a one minute hold time would require an absolutely huge amount of market restructuring. You would basically eliminate the ability to buy or sell securities on the open market, and drive the whole thing to private markets, or even further underground. It's a terrible idea.
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TheStupidOne, 14 Jan 2010 @ 10:35am

Re: Re:
Too much money ... wow, our government is really stupid isn't it?
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Michael (profile), 14 Jan 2010 @ 10:52am

Stocks, Futures, etc.
Investors in futures should have to have some obvious way of either storing or using what they buy the right for; I think this would limit speculation on oil and other commodities to those who are actually prepared to hoard or use them.

As for stocks and bonds, those are already imaginary constructs. I see them as bets on the performance of a company over time. Bonds being a direct loan (fixed repayment rate, but higher payoff priority?), and stocks being a more generic performance of the company tool.

I don't see a good way of compensating for stability while still allowing flexibility, so instead I propose a segmentation of purpose.

For long-term investment, time-locked transactions (hold for at least a week/longer, etc) should occur in one market. For shorter term, less than that period duration, either the companies directly, or owners of the other more fixed product could re-sell their contractual rights and obligations.

Insurance, in general, could also be sold as a sort of 'risky bond'. The end buyer must assuredly be disclosed of the full terms of the contract, and should never invest in anything they could not track down and evaluate independently. Investors would bet against the occurrence of 'failure' (payout to the insurer).
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Matt (profile), 14 Jan 2010 @ 11:16am

Re: Re: Re: Re: Minimum hold time?
This is more than a little exaggerated. Such a requirement is a bad idea, and would interefere with the market, but it would not require "the entire market structure" to be "torn out and regenerated".

The trouble is that not all high-frequency trading is bad, so it shouldn't all be prevented. One of the values of connected markets is that they allow traders to arbitrage across geography. HFT allows traders to arbitrage across time as well - so if an investor identifies a short-lived price movement, they can exploit that to their benefit. That in itself is not a bad thing - it just spreads the risk. The trouble is in volume, which can actually affect price and create the arbitrage.
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EH, 14 Jan 2010 @ 11:29am

Re: Re: Re: Re: Re: Minimum hold time?
> Such a requirement is a bad idea, and would interefere with the market, but it would not require "the entire market structure" to be "torn out and regenerated"

Yes it would - the market structure is predicated on having a bid and an offer up at all times. If you make people buy, wait 6 hours, sell, wait 6 hours, etc., you will completely eliminate that. Unless you want only "market makers" to have that ability, whereupon, 100% of the people who are high speed traders will simply register to become market makers in the securities they're interested in trading. In essence, such a requirement would either:

1. Require a complete tear down and re-build of the market structure
2. Completely f*ck over any small investor or small company at the expense of the people who can afford to work within those rules
3. Drive people to trade on exchanges which aren't retarded.
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Josh in CharlotteNC (profile), 14 Jan 2010 @ 1:12pm

Re: Re: Re: Re: Minimum hold time?
"Because nobody will invest if there is such a ridiculous requirement. What if you buy a stock, then news comes out and you want to unload it?"

That statement is demonstrably false. In fact, if you've ever actually done any work in the stock market, you'd know that there already is an effective 'minimum hold time' for the large majority of investors. Your trades do not settle for 3 days (do a trade on Monday, stock/cash in your account at market close on Wednesday, so you can't really do anything until Thursday). That's an SEC regulation already. The way you can get around that particular regulation is with a margin or day-trading account with your brokerage (they're offering you *credit* to buy and sell stocks - sound dangerous? it is). Most investors do not have those types of accounts.

(How do I know the above is true? I used to do tech support for ThomsonReuters financial products, some of which are involved in the HFT business, and I have a family member who is a broker for Bank of America.)

Now, on the other hand, my thoughts on HFT itself. I think HFT, even in the best case done by a responsible and intelligent brokerage, while not dangerous, is actually a net detrimental effect on the market. Why? It does NOT reward something risky that succeeds or punish something risky that fails. HFT allows large firms (the only ones who can afford the equipment to do it) to skim money off of smaller investors (frequently their own "customers"), not based on the merits of any particular trade, but by simple volume of doing as many transactions as possible - all it does is add in layers of middlemen in between a real investor and the company they wish to invest in. In the worst cases, HFT can be an unmitigated disaster for all the reasons in the previous thread on the subject.
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Clarence, 14 Jan 2010 @ 6:40pm

Think about it...
Before commenting on HFT and all the related topics, take a deep breath, count to 10 and then think about it.

Don't jump to conclusions.

Who here can say that they have personally experienced loss on the account of HFTs? Who here benefits from narrow spreads and immediacy?

HFTs just need better PR, but think about it, why would they expose themselves and generate even more competition or risk their strategies being reverse engineered. That's why they don't talk publicly much, not because they are trying rob the whole world.
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EH, 15 Jan 2010 @ 4:48am

Re: Re: Re: Re: Re: Minimum hold time?
>That statement is demonstrably false. In fact, if you've ever actually done any work in the stock market, you'd know that there already is an effective 'minimum hold time' for the large majority of investors. Your trades do not settle for 3 days (do a trade on Monday, stock/cash in your account at market close on Wednesday, so you can't really do anything until Thursday). That's an SEC regulation already.

In fact, I've been working in the market for about 15 years. I'm aware of settlement. Now, let me explain to you how it actually works. You buy a stock on Monday. You sell a stock on Monday. You get your money on Thursday. Unless you have 100% of your available money tied up in one single stock, you can repeat this as many times as you want.

So let's say you purchase a stock on Monday morning. An hour later, you hear news that the CEO has a severe drug and gambling problem, and has tanked the company - it's now worthless.

If you have a hold time requirement, what you are effectively saying is that everyone who purchased the stock more than 5 hours before you did is able to get out, but you are not.

I know this is kind of hard to wrap your head around, especially for someone who is not all that familiar with how the market works, but what makes it work is efficiency. The ability to get in and out quickly (HFT) is one thing, but what comes along with that is the ability for people who may not trade all that often to do it exactly when you want to.
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John, 26 Jun 2010 @ 6:59am

The riddle
The question I'd like answered, and then plastered all over the news : how much of a tax on transactions is needed to strongly curb HFT? Since it's 70% of the volume of the equity market, are we talking about a tax of
1/1000?
1/10000000?
1/10000000000000?

HFT feels like a legal version of the virus in "Office Space".
Europe is talking about a transaction tax, but they're worried that going it alone will chase away financial companies. Sure, the 200 HFT firms will leave. But it'd be nice to hear the US on this issue.
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Chickenpookie, 12 Oct 2010 @ 9:43am

HFT Trading
Where can I get an account managed by HFT's?

Thanks,
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