HFT
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Unless We Act, High-Frequency Trading Will Crash the Markets
High-frequency trading isn't illegal. But the way it is practiced today, it should be.
That's because high-frequency trading, or HFT, doesn't add to market liquidity, stability or efficiency -- but it could cause a catastrophic market crash.
Here's what's wrong with allowing high-frequency trading, what HFT practitioners say they're doing that's good for the market (which is rubbish), what could happen based on what has already happened, and what to do to fix this black hole.
The problem is HFT is based on a lie.
High-frequency traders send out tens of millions, if not billions, of orders to exchanges that are never meant to be executed. They are fake orders designed to dump manipulative information onto the nation's exchanges.
And while other market participants are not actually forced to adjust their bids and offers or engage in any of these trades, allowing access to the exchanges to manipulate anybody in any way is something that ought to be outlawed.
Exploiting an Unfair Advantage
In the HFT world it's all about speed. Without it, HFT wouldn't be possible.
There's nothing wrong with employing external innovations that speed up computers or the time it takes for information to get from one server to another. But HFT takes it to an entirely different level.
As I write this, chains of fixed microwave towers are being erected to send market data and orders between New York and Chicago because electromagnetic radiation travels only 2/3 as fast in glass fibers as it does through the air. The towers were designed and are being built by a pair of HFT entrepreneurs who already have HFT customers lined up.
And as soon as this winter passes, Hibernia Atlantic's Project Express will be dropping a more direct new generation transmission cable across the Atlantic so data and trade executions can travel faster between New York and London.
The new cable will reduce the 30 milliseconds travel time it takes now by only a few milliseconds, but space has already been leased to the only takers, the HFT crowd.
It may be unfair that some players are able to pay for a speed advantage by employing new technologies, but it's certainly not illegal.
What should be illegal, and is an abomination, is that the SEC allows exchanges to serve high frequency traders by leasing them co-location space next to the exchange's servers.
Not everyone can afford that access. But because it can be bought, HFT players have a significant speed advantage over everybody else who expects the SEC and the nation's regulated exchanges to guarantee equal access to get data and place trades.
Trust Me, It's Not About Liquidity
The HFT crowd argues that they act as market-makers and add liquidity wherever they practice their trades and both markets and investors are better served by their activity.
That's absolute nonsense.
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The Truth About High Frequency Trading and The Coming Market Crash
According to high-frequency traders and their backers, the super-fast, computer-driven stock trading desks that employ HFT are a benefit to investors and exchanges here in the U.S. and wherever they ply their trades.
But that's not true.
In fact, if you know exactly what high-frequency traders actually do and how they do it, you'll know what the SEC hasn't figured out, namely what caused the May 2010 Flash Crash.
You'll also realize that it's only a matter of time before these market manipulators cause a real catastrophic market crash.
Today I'll talk about what HFT players do and how they do it. And tomorrow I'll tell you how HFT could destroy our markets and economy.
What High-Frequency Traders Actually Do
High-frequency trading is fundamentally based on how market participants (for this discussion I'm talking about stock markets) place their orders to buy and sell shares and how HFT players act on those orders.
For every stock that's traded there is always (or at least it used to be "always") a "bid" and an "ask" price. Sometimes you'll hear the term "offer" or "offered" price, those terms are interchangeable with the term "ask" or "asking price."
The bid price is the price which someone is "bidding," or willing to pay to own shares. The ask price is the price which someone is willing to sell shares, or is "offering" or "asking" to sell at.
Bids and offers each come with the quantity of shares that the buyer or seller want to trade. There are millions of bids and offers made all day long, every trading day.
In fact, for every stock there are many bids and offers at several different prices.
The best bid, the highest price someone is willing to pay and how many shares they are willing to buy, and the best offered price, the lowest price at which someone is willing to sell their shares, constitutes a stock's current "quote."
In the U.S. we call that quote the NBBO, or national best bid and offer. But there are almost always other bids at lower prices and other offers at higher prices for all stocks.
High frequency traders employ pattern recognition algorithms that look deeply at bids and offers on stocks to determine if the movement on the bid quotes or offered quotes implies a directional tendency.
Computer-driven algorithms are "reading" the quotes, the intentions of buyers and sellers as they put down their orders in real-time, to make a trade that the HFT player expects to profit from if the directional bias their computers pick up is correct.
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High-Frequency Trading Could Cause Another Flash Crash
The threat of another flash crash caused by high-frequency trading is as great as ever.
And the next flash crash could be much worse than the one that shocked investors in May 2010.
Although the Securities and Exchange Commission (SEC) has taken some steps to prevent another flash crash caused by high-frequency trading (HFT), some experts question whether the additional disclosure and "circuit-breakers" designed to prevent big, sudden price moves will make a difference.
"Those things won't prevent another flash crash - they can't," said Money Morning Capital Waves Strategist Shah Gilani. "All they will do is soften the move."
The real issue, Gilani said, lies with the computers that execute the trades - thousands of them in milliseconds.
HFT has changed the nature of the stock market since these trades now account for between 60% and 70% of the transactions on the U.S. stock exchanges.
"You can't stop a flash crash unless you stop the computers from doing what they're programmed to do. And that's not being addressed," Gilani said. "The SEC is looking at keeping the ship from sinking, not stopping it from hitting icebergs."
HFT's heavy volume and high speed made it the prime suspect in the flash crash of 2010, when the Dow Jones Industrial Average plunged more than 600 points in five minutes, before recovering almost as quickly.
Mini Flash Crashes
Since then, the frequent occurrence of mini flash crashes - when a single stock or exchange-traded fund experiences a steep and rapid drop in price that quickly reverses - have served as nagging reminders of the vulnerability of the system to such events.
"It's like seeing cracks in a dam," James J. Angel, professor at the McDonough School of Business atGeorgetown University told The New York Times. "One day, I don't know when, there will be another earthquake."
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Low Stock Market Volume: It's Even Weaker Than You Think
Conventional investing wisdom tells us that when stocks rally on low stock market volume, traders perceive that lack of widespread participation as an indicator of the market's future vulnerability.
And as torrid as this rally in U.S. stock prices has been, the lack of trading volume has been a consistent cause for concern.
Unfortunately for market bulls, even this well-chronicled concern doesn't tell the whole story. That's because U.S. stock market volume is even worse - actually, much worse - than anyone realizes. And this ultra-low stock market volume should be sending up some serious red flags for investors.
To find out how Wall Street is artificially inflating stock-market volume, read on ...
