Soon We Will All Skip Most of the Day


There is an article on C1 of the Wall Street Journal today, by Kristina Peterson, titled Traders Who Skip Most of the Day. The article highlights a few former specialists who founded Briargate (an acronym of arbitrage) and are successful in allegedly practicing high frequency trading strategies. These gentlemen adapted, are successful, and are good family men, we are certain. We wish them continued success.

But we highlight them and the article for a different reason. Their strategies involve them being active, engaging in HFT, and “providing liquidity” at the open and the close, and then pretty much shutting down and staying away from the tape during the day (Open, Relax, Close). There is nothin wrong with that, as any individual or firm has the right to engage as they see fit, right? Well, not exactly.

 Collectively, if the market has become a collection of these firms, that at their best are engaging in hyper-short-term maker/taker rebate trading, and/or order anticipation trading,  then we have an explanation why the intraday volume patterns have never looked more U-shaped. The market has truly become a game of unregulated hedge funds/prop firms controlling such an outsized portion of our markets volume and pricing. In an article we wrote 18 months ago, What Ails Us About High Frequency Trading, we warned of the correlations, pricing distortion, and dangers of an “ocean” being dominated by one type of species (sharks). We are out of equilibrium, and while market forces, regulatory scrutiny, and media scrutiny are doing their part to swing the pendulum back to a more reasonable central position, the fact remains that in the interim, our markets between 10:00am and 3:00pm are a tumbleweed-strewn Wild West town that is unpopulated during the day.

Our equity markets have become a fragmented wiring mess of haphazard destinations being arbitraged by co-located HFT players. It is not pretty to look at, it is not elegant in design, and it continues to cater to short term trading versus investors at every turn. 

Equity outflows continue weekly (18 weeks in a row since the May 6th Flash Crash), and even SEC Chairman Schapiro acknowledges that it is a serious problem. Something has to change, more than at the margin too. 

Exchanges, heavily invested in the co-location revenue model, are fearful of losing that revenue. Exchanges, heavily invested in the market data revenue model, are fearful of losing that revenue. They need to understand however, that the danger of the paths that they chose is not a regulatory authority who will finally do something sensible for investors, but the danger is that they themselves are nearly done killing their own golden goose. Investors have fled the markets in droves. The remaining volume is predominantly HFT firms, and even they are taking off between 10am and 3pm. If this keeps going, there will only be a market opening, and a market closing, and hopefully even the exchanges know that you can’t make money selling the right to arbitrage that, and that there is a limit to how much you can charge for market data for two prices per day. 

But I guess the exchanges can just move on to other products and markets, again catering to short term speculators and encouraging them to leverage up (i.e. One-day options on ETF’s see here : 1-Day Options!)