The Fault Lies In Our Market Structure, Not Ourselves…

Every now and then this bares repeating. We at Themis are not anti-HFT. We are just plain and simple allies of long term investors. We are allies of owners of stocks rather than renters (PS owner in our book is not a very strict definition SMILEY FACE).

HFT practitioners, even the predatory ones, are just doing what our free market system wants them to do: make money by all legal and acceptable means, collateral damage be damned. The problem is our market stucture has evolved to cater to them. The for-profit exchanges cater to them. Our regulatory bodies have, in the past, rubber-stamped every “system and rule change” placed in front of them by the exchanges.

The result is what we have today: a market where the dominant players, HFT firms, take from the markets funds that belong to mutual and pension fund holders, although we do understand that the HFT firms add liquidity in SPY and Citi. They do this because the for-profit exchanges do their bidding at everyone else’s expense.

Joe, Victor, and I were recently discussing how “smart order routers”  seem to be designed to break up trades even more than the algo’s intentionally break them up.  Think about this… years ago, when a buyer and seller found themselves electronically, you might see two prints: 200 shares and 99,800 shares. Nowadays, if you are a seller in a name in size, and there is a buyer of that name in size as well, when  you match up in price, the result is 500 small trades ranging between  100 -2500 shares between the two of you in rapid fire succession. Are your “smart routers” acting in your interest? They are creating hundreds of un-needed opportunities for HFT firms, with their unfair co-located speed advantages, to prey on your order. The routers are creating increased visibilty and pattern recognition opportunities for HFT firms to get in between you and your natural other side. We will be examining routers more closely from a research perspective here. In the interim, as our clients, readers, and friends, have a read of this piece, done for the SEC and presented to them last year:

Some interesting points:

“We provide evidence that data revenue allocation has influenced the trading process”

“In addition, we would argue that market data revenue is an impetus contributing to the practices of payment for order flow, internalization, and order preferencing, but has largely been ignored in the literature investigating those practices.”

“To the best of our knowledge, this paper provides the first comprehensive academic study of this topic. It confirms that the incentives created by allocation formulas are large enough to have a significant impact on average trade size, that revenue-sharing/rebate programs are a key mechanism used by the exchanges to align the incentives of order-flow providers with the exchange, and that distortive impact of the old allocation formula was significantly larger in Network B than in Network A.”

“To the extent that market data revenue continues to be a major revenue source for exchanges, we suggest that data revenue may continue to play a significant role in shaping the industry.”

Two quotes I leave you with: 1) Shakespeare:The fault, dear Brutus, lies not in our stars, but in ourselves if we are underlings. 2) Remember The Titans: Attitude reflects leadership, captain.