Often we enjoy market structure making analogies that make use of animals and nature. Surely in past notes you may recall some of our imagery involving HFT and locusts, for example?

This week we are conflicted. On one hand it is Shark Week, so it would be entirely appropriate to have a nice hungry shark as our lead image. On the other hand we read an excellent blog piece over the weekend by Rajiv Sethi that invoked our fear of wiggly poison-spewing predatory spiders. Oh what to do…?

Aw Hell. Combine ‘em – in the spirit of Shark-nado, behold the image of the very rare… Shark-ider! Very scary indeed…

Beware the Alpha Sharks! High Frequency Trading and its Impact on Markets, written by Jason Voss CFA, highlights ITG and Cornell University’s Dr. Maureen O’Hara, volume-based clocks, predatory algorithms, and the importance of “being invisible.”  The article concludes with O’Hara’s list of six things you can do to avoid getting eaten by the Alpha-Shark HFTs.

The Spider and the Fly by Rajiv Sethi highlights the Michael Lewis pieces in Vanity Fair on Goldman/Aleynikov and HFT, just as we did for you on Friday. Sethi’s piece is extremely well though-out and written, and it contains remarkable perspective – it is a must read for anyone in our business.

Sethi correctly points out that it is not just speed that is the critical success factor in today’s markets – it is strategy – and more specifically prediction strategy – combined with a market set up to maximize intermediation.

“The key, as Andrei Kirilenko and his co-authors discovered in their study of transaction-level data from the S&P E-mini futures market, is predictive power”

We have been saying that our markets are broken for years, as technology has been perverted to maximize the amount of intermediation in equity markets. We have made that point on Bloomberg and CNBC, and we have made it extensively in our book. Sethi also nails it as he ties market structure, HFT, and financial intermediation together with Bogle’s Law:

It is commonly argued that high frequency trading benefits institutional and retail investors because it has resulted in a sharp decline in bid-ask spreads. But this spread is a highly imperfect measure of the value to investors of the change in regime. What matters, especially for institutional investors placing large orders based on fundamental research, is not the marginal price at which the first few shares trade but the average price over the entire transaction. And if their private information is effectively extracted early in this process, the price impact of their activity will be greater, and price volatility will be higher in general.

In evaluating the impact on investors of the change in market microstructure, it is worth keeping in mind Bogle’s Law:

It is the iron law of the markets, the undefiable rules of arithmetic: Gross return in the market, less the costs of financial intermediation, equals the net return actually delivered to market participants.

{…} All told, it is far from clear that the costs of financial intermediation have fallen in the aggregate.

We have a light economic news week ahead – perhaps quiet markets as well. Please enjoy these two articles and stay away from the Shark-iders!