Cinco De Mayo Hate Mail! Themis vs. HFT Smack-Down Debate

 

We received a bit of fan mail last night. Actually, maybe fan mail is not the right term, but I digress. A gentleman who works at a Chicago high frequency trading hedge fund wrote us a few spirited letters, which urge us to stop criticizing HFT, as it is not the small firms like his that are the problem, but rather the large “T-1 Banks” like Goldman, JP Morgan, Citi, and UBS, as well as the Exchanges that enable them. He urges us to speak out against them, and against the SEC for doing nothing about the un-level playing field that they have created with input from these same T-1 Banks and Exchanges.

Well, apparently he has not done his homework on us, because if he did, he would find that there is arguably no bigger critic of the Exchanges and Internalizers than Themis.

I think his letters demonstrate that the HFT-Free-Money-Irene-Aldridge-Anyone-Can-Do-It Era is over. HFT’s have eaten all the crops in the field, and they now eat each other’s lunch. His letters also demonstrate also how there are two wars going on right now in the Markets. One war is between large Bank HFT’s and Internalizers vs. the Small HFT’s who increasingly find it difficult to compete in a world where the Big Banks make the rules through puppets in Washington. The other war, which our letter-writing friend may not realize, is between the Exchanges vs. Banks in the Derivatives Space. The Exchanges want the Derivatives listed (duh). The Big Banks want them OTC so that the margins can be kept wide, as well as the space less regulated. It actually doesn’t matter who wins that second war; they both will win. And the world will lose, as leveraged synthetically created swaps and derivative products traded by leveraged high speed freaks can only mean a coming car wreck.

Our debate is spirited, but our letter-writer makes great points. I will only include his name if he writes me in and tells me he would like his name attached; we see no need to bring unwanted attention to him and his firm unless he wants that. Read on:

—–Original Message—–

From: Michael

Sent: Wed 5/4/2011 6:55 PM

To: Joe Saluzzi; Sal Arnuk

Subject: High Freq Trading

Guys,

I’ve read your web site and a number of your white papers.

I have an extensive market making and proprietary trading background.

You really piss me off. You’re beating on the wrong people.  Given you background, what’s’ your angle?

After the 1987 crash, John Vogel used to go on TV and scream about the evils of program traders. Now you’re screaming at HFT?  Why?

Did HFT cause the credit crisis? No.  Was there any flash crash induced in the Fall 2008 crash? No.  How did the market function in the Fall of 2008?  Fabulously.  What caused the Flash Crash of 2009?  1) Bad enforcement of existing regulation by the SEC.  2)  Idiots an NYX were not coordinated with idiots at NASDAQ as was required.  3)  And, a portfolio insurance strategy run amok by yet another idiot. Who benefits from the flash crash?  T-1s as it deflects attention from them, (and the SEC, FRB , UST, DOJ…) for the credit crisis evils and because they leverage the issue into reduced competition.

When I came to Chicago in 1985, there were some 1400 CBOE members and most were market makers. Now, there are some 100 only.  Why be a market-maker?  Where’s the upside? Where’s the risk-reward? How has systematic risk been reduced? Citadel buys 30% of every options order.

The villains are T-1 BD super powers who have hijacked exchange order flow while tacitly colluding with them.  Internalization is the real villain. To solve the problems you’re squawking about, simply cause the following to result.

1)      Route every order to an exchange first.

2)      Outlaw internalization and payment for order flow practices.

3)      Severely restrict pricing for NYX and NAS crossing facility. These are free facilities that undermine public markets.

4)      Provide positive incentives for market makers. Eliminate negative incentives for market makers.

a.       Gate direct exchange cross connects to registered market makers only. Give market makers only a latency edge and everyone will become a market maker including the T-1s.

5)      Loose all market gates. No price stops.  No time outs.  Let crash risk come back into the market. Right now, it’s been outlawed.

There is no free lunch.  The T-1s just use exchanges to manipulate Customer perceptions, so they can point to a price and pretend they’ve not stealing from them.  They were and remain bad citizens.  If left to their own virtually all trading would be crossed with their internal books, dark pools and customers and put up on NASDAQ for next to nothing. It’s almost free.  The “law of one price” and the truth of “price discovery” has been violently assaulted. T-1’s and policy maker collusion has destroyed competition. We do not have competitive public markets.  Citadel has their hands of >30% of every options trade? They buy the order flow. Is that competition?

Policy makers are either dopes or in the bag of the T-1s who gave us LTC, the internet bubble, Enron, Madoff and the credit crisis.

Squawking about HFT does not reveal the truth about the real villains.  Point the finger at the T-1s not the small firms.

Enhancing the quality of public market should be the sole purpose of the DOJ and SEC. The naked access issue constitutes a complete sham. The press doesn’t want to hear that.  It already exists!  All it does is further entrench the T-1s.  Who benefits?

Wag your righteous figure at the right villain.

Mike

Michael XXXXXXXXX

XXX Capital Management, LLC

XXX Trading Fund LP

South La Salle

Chicago, IL  60604

xxx-xxx-xxxx – desk

xxx-xxx-xxxx – cell

—–Original Message—–

From: Sal Arnuk [mailto:SArnuk@ThemisTrading.com]

Sent: Wednesday, May 04, 2011 6:30 PM

To: Michael

Cc: Joe Saluzzi

Subject: RE: High Freq Trading

Thanks for writing us. I don’t usually respond to folks who start off about how we really “piss them off”, but I’ll give you the courtesy.

We have plenty of squawk for the larger HFT regulatory-capturing fake market makers and internalizers. But if you sat in our seat you would also see the predatory crap we see all day long. Much of that is small HFT predatory crap. I don’t think anyone knows or understands the real effects of hot potato run-ahead-of-the-next-guy games in today’s markets. Our views come from a decent clip of experience, though. I can show you some of your competitors’ games in action on any given day. Perhaps they are even some of your games. It doesn’t matter, though. The HFT bubble has rumbled through our equity markets leaving a crappy barren field behind, and is now going global and in other products to keep the frenzy alive. An HFT system of 65% hyper-scalpers feeding on the ever-diminishing owners of the market is not sustainable; I am surprised you think that it is. The market has room for all participants, but in equilibrium. I am not sure what that equilibrium is, but it has gotten out of whack.

It seems all was good in HFT world when it was not discussed ad nauseam. Sadly, for you, that is not the case now. Sadly, the very system that allowed all HFT to prey on the slower now has the largest and most connected large HFT using their lobbying prowess to force out the small HFT.  It seems that this is your beef. Smaller HFT firms can get lobbyists too, as some have done, and some firms (like ours) can instead squawk with decent effect. We are sorry you are unhappy with our voice. We are unhappy with the hijacking of the markets. And we do know that it sucks when the very “survival of the fittest” song that you preach turns on you and threatens your lunch. Big HFT vs. Small HFT. You won’t win that one.

Can we post your viewpoint? We don’t agree with it, but hey, we’ll give you the airtime. PS our blog has no advertising, and we use it for informing and communicating. No axe to grind there.

—–Original Message—–
From: Michael
Sent: Wednesday, May 04, 2011 8:55 PM
To: Sal Arnuk
Subject: RE: High Freq Trading

What part of my comments don’t you agree with? What specifically do you define as HFT? You offer no solution. All you do is play victim. Wah. Wah. Wah…Stop whining. Do something positive. Scream at the T-1s. Scream at Levitt. Scream at the SEC.  Do you really think more bad regulation is the solution?   HFT is a nonsense term. You’re pissed because you don’t get it. You don’t have the right vision or the right technology.  You think guys like me are screwing up your parade.  It’s not me or folks like me.  It’s those that control the order flow in a systematic manner. That’s the T-1s who internalize everything first. Do you think GS would every have the guts to be a real competitive market maker?  They don’t want to compete. They never have. 

I can give you sub microsecond performance. Want it?  I will give you the source code. How’s that? If you want it, I  can give it to you. It’s sub micro.  I might just put it up on the as freeware for all.  Would that make you feel any differently?  It’s hardcore Linux. Do you have HPC developers that can appreciate it, or, are your servers still in your office? Do you build your own applications or do you use some commercial crap. If you are not using at least state of the art computing techniques, then you are already dead and you are not doing your clients good service.   In one box I can make tight markets in all exchange traded products simultaneously. All products simultaneously. 5000 stocks. 1000 ETFs. All options. All futures.  All FOREX. Brand new hardware would cost you $15K. DC OPEX is another $15K per month. These are market prices. Im not trying to sell you.  1 mic on the exchange with pre-trade risk, all in. Do you want it?… it won’t help you.  You have to route.  Routing is a millisecond game.  Why? Because that’ what the T-1s want.  Why is Citadel 2.3 milliseconds IOC and GS is 30 milliseconds? This is ack time going to their dark pools. What is GS doing for 30 milliseconds? Are they just stupid? Can’t figures out technology?…If “high frequency” capabilities is what mattered, then I’d be Midas…. It’s not what matters. The technology is not what matters. Unfair playing fields is what matters to a few.  A fair playing field is what matters to the public.   That’s why the T-1s have engineered the landscape into what it now is – the barren crap you describe.  It’s not competitive. Price is not competitively determined.   The T-1s were never market makers. They were always carping markets and whining the whole way.  They hated the exchanges. So they engaged in a series regulatory flanking moves. They are bad guys. They created the opportunity for massive internalization which IMO represents diverting the Mississippi through toll gates they’ve constructed. Where’s the law of one price when you are most trades and volume to do filter directly into the exchange price. They’ve laid barren the fertile fields.  They’ve usurped a public good. Honest price discovery. They’ve corrupted the cost of capital. But the exchanges themselves – NYX and NAS are in cahoots as enablers. This is the problem.  Bad regulation. Bad enforcement. Bad policies.  They love you. When you get on the tube on your high horse, you are helping them. You are making things worse for the truth to be revealed and competition to hopefully emerge.   If you want to change the environment you need to speak out against the T-1s, regulators and exchanges and you need to embrace what you describe as HFT. Fight fire with fire.   I’ve always thought of the T-1s as scum who can only succeed through cheating. Small is beautiful. I don’t want to win.  I want to be a small fish in a big ocean.   You are wailing at the moon.  By definition, exchange members of old had huge latency advantages. You want to go back to that system. Never happen.. It had some good features, namely the law of one price prevailed. Look at the CME.  It works well.  Look at the US equities markets….  Do you want more market makers to make stupid markets in illiquid stocks?  Why not throw out a shingle? Go grab a seat. Start making markets yourself?…If you do want more market makers making tight markets in illiquid stocks then get with my 5 simple steps to re-empower exchanges and drive all order flow to where it can fairly be priced.

It’s late.  This prose needs polishing.  But, I’m tired.  Post it if you want.

M

Michael XXXXXXXXX

XXX Capital Management, LLC

XXX Trading Fund LP

South La Salle

Chicago, IL  60604

xxx-xxx-xxxx – desk

xxx-xxx-xxxx – cell

Where we left off 4:00pm EST:

INDU              12,723.58                                -83.93

SPX                 1,347.32                                  -9.30

CCMP             2,828.23                                  -13.39

Futures now at 7:00 am EST:

DJA                             -34 

SPA                             -5.80

NDA                           -9.25

Key Data out today:

 

08:30:              Non-Farm Productivity

08:30:              Jobs data (delivered in machine readable form to HFT’s before you can react, so do not try to)

Since the prior close, some key stories:

 

–       Commodities and stocks fall again this week

–       Lloyds sets aside $5.3 billion to cover loan insurance losses; shares fall.

–       Glencore IPO Shows Unregulated Commodities Traders Eclipsing Goldman Sachs (Bloomberg)

–       Food Prices Approach Record High as Grain Prices Fuel Global Inflation (Bloomberg)

–       Asian Oils under pressure due to potential China 10% Resource Tax.

–       High Speed Traders Head For Exits – WSJ: Read Here Even Manoj says times are lean. Brother Can You Spare a Hundredth of a Dime?

–       Clinton wants to give Qadaffi’s $33 billion to the Rebels.

–       Obama will visit Ground Zero this morning.

 

 

Earnings:

 

Pre-market:  ACM, AEE, ARG, CI, CNP, CVS, DTV, EL, EP, FTR, GM, HUN, MFC, NRG, PEG, PGN

After the Close: CF, CNQ, EOG, FLR, KFT, SUN, V

 

Significant Movers This Morning:

QNST +15%, SHS +11%, JDSU +10%, PPO +8%, RDN +8%, HNSN +7%, MW +6%, TKLC +5%, WFMI +5%, BMC +5%, TSLA +3%, GERN +3%, MELI -5%, ATML -7%, BMY -4%