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Loving The Bomb

07

June, 2012

 

Leah McGrath Goodman has authored an article in June’s Absolute Return titled How Wall Street Learned to Stop Worrying & Love the Bomb (well maybe not love, but tolerate). The title is obviously a takeoff from the 1964 movie Dr. Strangelove or: How I Learned to Stop worrying and Love the Bomb, a movie in which an insane general starts a process to nuclear Armageddon that a war room of politicians and generals frantically try to stop.

Sadly, regarding HFT, and unlike the movie Dr. Strangelove, the “war room of generals and politicians” are not trying to stop HFT, but rather they are frantically trying to protect it.

The lead in to her article is, “Two years after the flash crash, hedge funds and other sophisticated investors have begun to appreciate the benefits of high frequency trading.”

The article is mostly balanced, with perhaps a leaning towards a “what’s the big deal – yawn” painting about high frequency trading. It is worth a read. She does do a nice job of assembling a balanced group of folks to interview; the list of contributors to the story includes:

AQR’s Mike Mendelson, (pro HFT)

Rosenblatt’s Justin Schack, (anti-anti- HFT)

Metropolitan Capital’s Karen Finerman (CNBC Fast Money regular), (neutral HFT)

Nobilis Capital’s Chris Bartlett, (pro HFT)

Masters Capital’s Mike Masters, (anti HFT)

Duke University’s Harvey, (neutral HFT)

DRW’s Don Wilson (pro-HFT)

Virtu’s Chris Concannon, (pro-HFT)

Nanex’s Eric Hunsader, (anti-nefarious HFT and pro-marketmaking-no games-HFT)

Pragma’s Mechner (neutral HFT)

 

What will you learn from reading this article?

 

-          HFTs often employ only a few million dollars in capital to trade hundreds of millions of shares per day.

-          The SEC/CFTC didn’t even interview Barclays, the algo provider Waddell and Reed used on May 6th for their flash-crash inducing 9.9% volume passive participation algo in the eMinis, the world’s most liquid instrument, where they were 1.2% of the volume that day, until weeks after they issued their report blaming them. Also a Freedom of Information Act request filed by Waddell seeking more information about their findings was denied.

-          Virtu’s Concannon admits that while “we have 13 exchanges and 30 dark pools, once you break through the top layers of liquidity there’s not a whole lot underneath.”

-          Nanex’s Hunsader hypothesizes that quote stuffing, such as the kind seen in April where 47,138 quote changes in 1 second with 0 trades, is often done to target specific stock exchange servers, with specific symbols, in an attempt to create latency arbitrage.

-          NYSE’s Niederauer points out that while dark trades account for perhaps 35% of the entire equity market, in 1,300 stocks the dark percentage is 50%.

-          TABB estimates that in 2011 HFT firms earned only $4.8 billion, compared to prior much higher estimates.

-          The current speed of HFTs hover between 2 and 5 microseconds – millionths of a second (the speed of the SIP most ALGOS run off of is 1,000 times slower)

 

While we agree with the article’s suggestion that Wall Street (most brokers, exchanges, and trading firms) is not worried about HFT, we know full well that this is not the case among the investment community. We visit with money managers, only some of whom are clients, as well as professionals in the retail community. They hardly “love the bomb”. Go ask large mutual funds in parts of the country ranging from Baltimore, to San Francisco, to Boston. Go ask the folks who have withdrawn nearly $300 billion in equity funds since the Flash Crash.

And consider this: if the investment community were really “coming to love”, or tolerate HFT because of HFT’s narrow spreads and liquidity volume, why is there such a hard sell behind the scenes in Washington DC, and our regulators, to make sure HFT is not impacted by regulation?  Follow the money – the lobbying money.

Are you all aware that folks in Washington DC are trying to define HFT, and from a legal standpoint? Are you aware that this definition is likely to be so broad so as it includes your mutual fund one-direction algorithmic orders? Think about it. If HFT is in the same bucket as your VWAP order, from a legal standpoint, the chances of a tax on HFT (cancellation fees, transaction fees) approach zero.

No. Investors do not tolerate HFT. They don’t love it either. They are voting with their feet, and our economy and wealth is suffering as a result.

 

 

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