Home > finance, hedge funds, news > High frequency trading: Update

High frequency trading: Update

July 18, 2011

I’d like to make an update to my earlier rant about high frequency trading. I got an awesome comment from someone in finance that explains that my main point is invalid, namely:

…the statement that high frequency traders tend to back away when the market gets volatile may be true, but it is demonstrably true that other, non-electronic, non-high-frequency, market makers do and have done exactly the same thing historically (numerous examples included 1987, 1998, various times in the mortgage crisis, and just the other morning in Italian government bonds when they traded 3 points wide for I believe over an hour).  While there is an obligation to make markets, in general one is not obliged to make markets at any particular width; and if there were such an obligation, the economics of being a marketmaker would be really terrible, because you would be saying that at certain junctures you are obliged to be picked off (typically exactly when that has the greatest chance of bankrupting your enterprise).

My conclusion is that it’s not a clear but case that high-frequency traders actually increase the risk.

By the way, just in case it’s not clear: one of the main reasons I am blogging in the first place is so that people will set me straight if I’m wrong about the facts. So please do comment if you think I’m getting things wrong.

Categories: finance, hedge funds, news
  1. JB
    July 18, 2011 at 3:55 pm

    Hi Cathy,

    having left math academia for finance myself, I enjoy reading your blog. But I don’t share your negative view of Wall Street in general, and I got quite puzzled with what you call your HFT rant.

    Your overall tone seem to be negative, and for those far from finance, you portray HFT as the “bad guys”. Now this is exactly the reason why there appear to be more interviews with people involved in HFT nowadays – it’s not that they (OK, we) want people to like us, it’s just that the public perception of HFT is so far from the reality, that people will believe any accusations, no matter how ridiculous they are.

    I don’t really get what you complain about:

    1) buy low sell high is pretty much what 99% of trading is about, HFT or not.

    2) regarding flash crash and market making obligations, you’ve already received a response, I can add Jim Simon’s observation, that without HFT, market crash last May would still happen, but it would’ve taken days/weeks instead of hours for the market to rebounce.

    3) Finally, regarding your analogy – yes, it may be inconvenient for you to find the dish washing guy absent when you need him most, but that doesn’t mean, you should pass a law, that whoever is doing your dishes this month is obliged to do them whenever you want for the next month or year (which is more or less what SEC is trying to do).

    best regards,
    your HFT guy.

    • BG
      July 24, 2011 at 1:42 am

      I think that HFT is pretty disruptive to markets . There are enough sources of volatility . There is no reason to add another source that has no basis in market fundamentals. The market exists for an open economy, not for traders . One of the consequences of the ridiculously low taxes on high income individuals, is that now, the market seems to exist for the traders and HFT just exacerbates this imbalance.
      As to your remark on making a market, at one time, when I was younger, specialists existed to help maintain an orderly market and had capital requirements and obligations to buy up the shares that people might be dumping in a crash. Market makers had obligations to honor their ids and asks and were supposed to lose their market making status if they did not. This instilled confidence in the public and encouraged them to invest. HFT has scared off the public from investing. Henry Ford, as disgusting as his politics was, recognized the need for blic to be his consumer. HFT traders do not care and are destroying what is left in faith in the market. It makes a big difference to someone if the flash crash happens in seconds or days or weeks. Seconds does not give them any time to react and is psychologically debilitating. HFT traders do not care about the impact of what they do just as billionaires who ask for tax breaks do not care if they break the US .

  2. FogOfWar
    July 25, 2011 at 11:44 pm

    With all due respect, HFT Guy, I think you may be suffering cognitive capture (not to say HFT is the pure evil its made out to be–there are arguments on both sides).

    http://www.bankofengland.co.uk/publications/speeches/2011/speech509.pdf

    I love Jim Simons, but he is talking his book here.

    Point 3) describes a regulated market maker (and I don’t think regulated market makers are forced to make markets for years if they decide to stop making a market–they just can’t stop making a market every time it’s inconvenient for them and then step back in 2 days later). The observation is that the algo shops are market makers who have arbitraged away the “regulated” part…

  3. human mathematics
    August 30, 2011 at 3:14 pm

    Cheers to you for admitting when you’re wrong.

    In my opinion HFT’s do little to move prices around. Maybe I am just talking about UHFT’s but it seems like just a game to serve the customer first, with no power to dictate prices.

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