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Are HFTs The Markets Marionette?

by on March 31, 2014 5:50 am GMT
 

With the abundance of probes into various market manipulations, it is common ground to believe the market is rigged; and high frequency traders (HFTs) has been under scrutiny that their ability to trade millions of shares in the blink of an eye as unfair and should be illegal. According to author Michael Lewis, who is researching HFTs for a new book called “Flash Boys,” said that these computer-based trading algorithms are so complex that individual investors cannot understand them.

Well, so what? Not many traders fully understand the highly complex math, partial differential equations, that goes into the Black-Scholes pricing model for derivatives, yet there is no attack to outlaw equity options:

\frac{\partial V}{\partial t} + \frac{1}{2}\sigma^2 S^2 \frac{\partial^2 V}{\partial S^2} + rS\frac{\partial V}{\partial S} - rV = 0

 

See, the problem is that those that attack HFTs assume that all firms receive news or data prior to a release. “It’s crazy that it’s legal for some people to get advance news on prices and what investors are doing,” said Lewis. But, that is irrelevant. That is a completely different topic all together. Insider information is unfair whether it is done by a computer or a human.

Trading is binary. There are only two possible outcomes on every trade. You either win or you loose, and that goes to the HFTs and non-HFTs, retail traders and institutional traders. Over the last three years, quantitative trading funds, which employ these highly complex strategies, have under-preformed the global market over the last three years as a whole. However, there are winners like Virtu Financial Inc., which has had one losing day in five years.

As floor traders became obsolete due to technology and the effects of the 2008/9 financial crisis, exchanges rely heavily on these HFTs for liquidity. There is even data to point towards lower overall trading-related fees.

Do not get me wrong, there needs to be compliance and standards. Flash crashes are not good for anyone, and Knight Capital almost went bankrupt in a day due to algorithm malfunctions. Nevertheless, to assume all HFTs trade on insider information is ludicrous. Lewis and New York Attorney General Eric Schneiderman can fight for HFTs standards, but it must be more focused then a blanketed attack.