The challenges of high frequency trading lie deeper than it sounds
"The United States stock market, the most exemplary financial platform of global capitalism, is infected with fraud." This is what Michael Lewis said to Steve Kroft on CBS '60 Minutes evening TV show. Michael Lewis chose a witty, though slightly exaggerated, the way to express the main theme of his new important book " Quick Boys » (Flash Boys). This is a provocative book about the outrageous methods of high-frequency trading.
Mr. Lewis’s well-thought-out story draws attention to the perverted Wall Street system, which provided the opportunity for some professional investors for several hundred million dollars to place their computer servers as close to stock exchanges as possible. This allows them to overtake the rest of the exchange players by a few milliseconds.
In some cases, “high-speed” investors can bit by bit collect crucial information from trade data streams entering their systems. Thanks to these data, they can watch what shares other investors are going to buy before executing their orders.
But there is one problem in Mr. Lewis’s story: he attributes the blame to the wrong villains. He mainly blames hedge funds and investment banks engaged in high-frequency trading.
However, it seems that Mr. Lewis is silent about the real culprits: large stock exchanges that capitalize on providing superfast access to certain investors.
While large banks with Wall Street may have invented high-frequency trading, it gained widespread popularity due to the fact that it was supported by such stock exchanges as the New York Stock Exchange, Nasdaq and Bats - an electronic stock exchange system, which has become a pioneer in this field. These exchanges not only passively allow you to connect to your systems. They created systems and different price levels specifically for high-frequency trading. For higher speeds, they charge a higher price, and select customers are provided with more data. In other words: the more you pay, the faster you trade.
This is what the real problem is: exchanges have a financial incentive to create unequal conditions.
This does not mean that “high-frequency” hedge funds and banks are not involved in this. They are also accomplices. And some may have gone beyond simply following the rules. Eric Schneiderman, Attorney General of New York, recently launched an investigation into high-frequency trading.
“There is a possibility that some things here may be illegal,” he said in an interview with Bloomberg News. “There are some things that may be legal now, but should be considered illegal or the markets will have to change.”
If - and we hope that this happens - the rules will change, the new requirements are likely to be followed by exchanges, not investors. New rules may force exchanges to block or modify the special data channels that they created for high-frequency traders. Equally important, exchanges may have to find a way to create speed bumps in the system so that all investors can trade at the same time, regardless of the speed of the fiber optic cables that they run in order to take advantage. It would be very similar to the system that the protagonist of Mr. Lewis’s book, Brad Katsuyama, developed to slow down the speed of high-frequency trading. He created an alternative electronic exchange called IEX.
Of course, while Mr. Lewis is arguing against high-frequency trading with a clear division into good and bad, with legal regulation, things are much more complicated.
On 60 Minutes, Mr. Lewis made it seem simple: “Insiders can act faster than you. They have the opportunity to see your order and play against other orders in such a way that you will not understand this. They can conduct a leading deal against your order. ”
The problem that regulators are going to solve by creating new rules is that the fight against high-frequency trading is not just a duel between David and Goliath. But this is not a confrontation between a small beginner investor with E-Trade and a sophisticated high-frequency trader.
High-frequency traders earn most of their huge money by competing with other large organizations. Mr. Lewis claims that high-frequency traders, having unfair advantages, put ordinary people's pension funds at risk. This may be true, but only partially: where do you think high-frequency trading companies get their money for investment? From pension funds. Thus, things get complicated quickly.
Stock exchanges that serve high-frequency traders often justify this method of working, stating that such trading adds to the market liquidity and reduces prices that all investors pay. In a sense, this argument is valid. The amount that investors pay has declined markedly over the past few decades. Advocates also add that there has always been some form of intermediaries in the market who “skimmed the cream” from each order. High frequency traders just do it more efficiently.
Oddly enough, Goldman Sachs, one of the first high-frequency traders, supported the creation of new rules to make the system more honest and stable. However, if a firm is serious about its position, it should consider abandoning some of its customers or exerting pressure on them to change their working methods. Goldman is the underwriter of Virtu Financial's upcoming first public offering (IPO), which specializes in high-frequency trading.
Next comes the question of the responsibility of the Securities and Exchange Commission. Until recently, the agency not only looked blindly at such "high-speed" deals, but also actively encouraged them. In recent months, the commission has finally begun to consider the need for rule changes.
Mr. Lewis draws general attention to this issue, the solution of which, hopefully, will make the markets a little more honest. (However, there are still a huge number of other problems that still allow fraud to flourish). But it is important that the new rules relate to the real culprits of dishonest play, and not just light targets.
PS If you notice a mistake, typo or inaccuracy of the translation, write in a personal message and we will quickly fix it.
Related posts and links: