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Treat The Disease, Not The Symptoms

13

May, 2011

Traders Magazine has a cover story this month titled “Defending the Turf: Sellside Moves to Protect Buyside From HFT OnslaughtRead Traders Magazine article here.  Before the author of the article gets into his story about how sellside brokers are trying to adjust their algorithms to deal with the predatory practices of high frequency trading, he makes this statement: “The more common HFT trading strategies involve market making or some form of arbitrage. These strategies are considered beneficial for the market as a whole, as they supply liquidity and keep prices close to fair value.”  And we were hoping for a well-balanced article and the first thing we read is about how HFT supplies liquidity.  Too bad the author doesn’t also state that HFT demands even more liquidity than they supply. Maybe we will send him a copy of the May 6th SEC report.

Anyway, the story is about how the sellside is helping the buyside with their new algos, new smart routers and
supplying them with information about how their orders are executed.  The article also has two side boxes where they discuss particular HFT strategies: Latency Arbitrage (we thought Manoj said that this doesn’t exist) and Liquidity Detection (post only orders).  Unfortunately, these examples are only in the print edition and not in the online edition.  We commend Traders Mag for taking on these two controversial practices and even calling out Nasdaq and NYSE Arca as two exchanges that offer post-only orders.  We hope they don’t get mad at you and pull their monthly advertisements.

We are happy to see that the sellside is finally hearing the concerns of the buyside.  It only took them a few years and lots of institutional pressure to realize that HFT was picking off their algos.  We like to think that some of our analysis and writings may have had also helped to influence them.  But what is the sellside really doing with these anti-gaming algos?  They are simply responding to an equity market that is now dominated by hyper speed, short term players.  We all know that the large HFT’s have an almost unlimited budget when it comes to technology, so doesn’t it make sense that any anti-gaming technology will be quickly discovered and exploited.   One buysider in the article said this: “It’s all well and good that brokers are continually refining their anti-gaming tools. But when you’re competing with technology, it won’t be long before the improved logic is gameable.” While we applaud the sellside for trying to make their algorithms smarter, they really should be addressing the root cause of the problem. Rather than treat the disease, the sellside is now treating the symptoms. They need to address why they have to react to HFT in the first place.

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