One of our good friends, DC, stumbled upon a neat interview on All About Alpha yesterday with an HFT Executive/Partner at an HFT Firm. This executive also founded a technology company selling technology collocation and technology services to HFT firms. The full interview can be read here.
We would not expect this salesman to state anything other than HFT is volatility-dampening, and how it provides valuable liquidity and grease to the markets’ workings every day; he does a) practice it and b) sell expensive services to HFT firms outside his own firm. However his comments apply to one type of high frequency trading: market making, and none of the predatory types. In addition he asserts that market makers are passive; they never hit the bid or take the offer, and because of that they dampen volatility and make market moves smaller than if they were otherwise not in the market.
We take issue with his statement, respectfully, and would like to add some questions to the interview, and the answers that we think would likely follow, if we crashed the set:
Themis: So HFT market makers just passively bid and offer, and don’t cross the spread?
HFT: Yes that is so.
Themis: So you are just maximizing the rebate structures created by the exchanges?
HFT: Yes. That is what any capitalistic and red-blooded successful trader would do.
Themis: Do you know what an inverted rebate structure is? Like when an exchange pays you to cross the spread?
HFT: Don’t be ridiculous. Of course I do.
Themis: So if you buy at $0.50 and get rebated on one exchange, you could turn around and instantly sell it at $0.50, cross the spread and get rebated again?
HFT: Uhhhh. Yes.
Themis: That was one of the Exchange’s “financial innovations” to allow you guys more permutations to be profitable, so as to rent their colo space etc. Right?
HFT: Where are you going with this. I have to leave. Who is that behind you?
Themis: Wait just a sec. Humor us please. So by your own definition, even the “most benign” type of HFT, market making, is not always “passive” (defined by crossing the spread… your definition; not ours)?
HFT: I suppose that is true.
Themis: Do you remember May 6th, 2010?
HFT: Very funny. Please tell your partner to stop blocking the door.
Themis: Oh ignore him; he is just tying his shoe… But remember how the CFTC/SEC Joint Advisory Committee talked about hot-potato lemming-like behavior, when one guy hit a bid, and another was left holding inventory, and then that guy hit a bid, and then two friends joined them both, and so on, and so on, like the 1970’s Breck Shampoo commercial?
HFT: I have a car waiting for me outside; if you’ll excuse me and just let me pass…
Themis: Hang on Cappy. In that type of scenario, when data feeds get stuffed, slow down, and latency-arbitrage-on-demand kicks in, is the “passive volatility-dampening” you refer to in the first half of the interview the same type of trading that the CFTC/SEC Joint Advisory Committee described as greatly exacerbating the Flash Crash?
HFT: Security! Security!
Themis: Relax. We were just leaving. Nothing to see here anyway. Just more of the same.