HFT, Code Cracking and Yellow Caution Tape


In our morning note, we often tackle some tough market structure issues.  Many times we have taken issue with some aspects of high frequency trading.  We often feel like it is a battle that we fight with an enemy that we can’t see.  After all, except for the guy above the hardware store in Red Bank, NJ, nobody in the HFT community likes to speak publicly.  We are not quite sure why they don’t speak more.  Are they hiding something from their competitors or the regulators maybe?  Or are they just too busy writing code and counting all those profits to give interviews?  We are not really sure and we really don’t care.  But when you get a rare chance to hear an HFT speak, we do listen.  And when you hear the Grand Daddy of the Quants, Jim Simons of Renaissance Capital speak, then we listen very carefully.

 Renaissance has compounded at 30% per year return since 1988 including an 80% return in 2008.  They have no outside investors, according to Simons, as it is 100% employee owned.  Simons was a former code cracker for the U.S. National Security Agency.  Read this 2008 Bloomberg article for a good history of Renaissance and Simons: http://noir.bloomberg.com/apps/news?pid=nw&pname=mm_0108_story1.html

 But to really get a feel of who Jim Simons is and what he stands for, you have to watch this video of him addressing an audience at MIT: http://paul.kedrosky.com/archives/2011/01/james_simons_sp.html 

 Here are a few parts that we thought were interesting:

 34 minute mark:  Simons was talking about what made Renaissance so successful.  People would always ask him “What’s the secret”.  He said he won’t talk about the various “predictive signals” and that he needs to guard those secrets. 

 48 minute mark: Question from the audience, do you consider HFT socially useful?  Simons says yes and believes that highly liquid markets are useful.  He says that HFT adds liquidity and helps lower market impact.  He says that the “specialists” of old were “full of baloney”.  But then he says “the more volume the better. And its volume that has been created by the high frequency traders.”

 50 minute mark: He says that the May 6th “Flash Crash” was a glitch. He brushes off this event as an 8 minute event and that the market came right back.  He says the May 6th event was “a little destabilizing” but when the algorithms kicked backed in, then everything was fine again.  He thinks that the people who argue against HFT are “wrong”.

 Well there you have it, Jim Simons says we are wrong so we might as well just stop working on our next paper and just create an algo to go along with everybody else on the Street.  We don’t think so.  Now more than ever, markets need to be put under the microscope.  Because around every corner, there is a guy looking to take advantage of either a regulatory or technological discrepancy at the expense of the traditional investor.  They want us and other market observers to just go away.  They are like the traffic cop at the scene of an accident saying, “Nothing to see here folks, just keep moving.”  But we know what is behind the yellow caution tape and we intend to make sure that all in the investment community know as well.