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The High Frequency Four Horsemen


July, 2011

This past Wednesday, the Financial Times printed a letter to the editor from R.T. Leuchtkafer (RTL). RTL is a private investor who just happens to know alot about the inner workings of the equity market. We have had the pleasure recently to correspond with RTL and even were fortunate enough to co-author a paper with him on the anniversary of the Flash Crash Read Paper Here His letter to the FT is brilliant and a must read for all investors who care about the future of our equity market. We won’t spoil the read for you but wanted to specifically highlight one line in RTL’s letter:

“The high frequency four horsemen of privileged market access, privileged market data, destabilising trading practices and deregulation still march toward Armageddon.”

This one sentence basically summarizes what is wrong with the equity market model. Please read RTL’s letter:

Market forces will not stop flash-crash Armageddon

From Mr R.T. Leuchtkafer.

Sir, Larry Tabb (“Playing ostrich over high-speed trading is not an option “, July 14) worries about a “technology-led market Armageddon”, yet suggests regulators should stand aside and let market forces sort it out.

The thunder, lightning and earthquakes portending Armageddon – the May 6 2010 “flash crash”, fragmentation, declining volumes, loss of confidence, the public’s flight from equity markets – don’t convince Mr. Tabb that regulators must act.

Regulators have so far done very little. New initiatives since the flash crash include only a round or two of circuit breakers and a swap of laughable market-maker obligations for merely amusing ones. The big issues, the high frequency four horsemen of privileged market access, privileged market data, destabilising trading practices and deregulation still march toward Armageddon.

An insightful observer, Mr. Tabb is rightly concerned about the unintended consequences of regulator intervention. But what of the unintended consequences of market forces – or, worse, the intended consequences of market forces?

Market forces gave us the flash crash itself, and hundreds of mini flash crashes before and since in every imaginable asset from Apple Computer to West Texas Intermediate.

Market forces gave us some 250 market centres and counting in the US, such that if you straight-line the downward trend in the number of publicly listed companies with the upward trend in the number of dark pools, internalisers and exchanges, the US will eventually have one market centre per stock. Market forces sold confidential order data to high frequency firms, which these firms then used to pick off public investors.

Enough’s enough. Instead of an antediluvian faith in market forces despite massive evidence of market failure and abuse, we need regulators to act. Whether regulators will find these problems more comprehensible than their own office leases, we can only hope.

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