How To Combat HFT?


An article in The Globe and Mail describes HFT as being on the wane in Canada, according to a study by ITG’s Doug Clark.

Canadian stock markets may be entering a “new regime” as high frequency trading starts to show signs of shrinking its role in share trading, according to a new report from brokerage ITG Canada.

“This quarter’s analysis of message traffic data reveals changes in trading behaviour that may signal the beginnings of a new regime,” ITG’s analysts wrote. “Improvements in our metric for the quality of order flow, combined with a decline in fleeting orders points to a structural change amongst HFT participants.”

Doug goes on to explain that they believe this is the case because HFT’s are marginally less profitable, as so many of them have shown up to play the same game. He also credits better products/algos from brokerage firms who are providing institutions products that handle trading better, as they limit interaction with HFT.

We agree with Doug’s points, and add to them. The buyside is so much more knowledgeable today compared to just two years ago, and understand that the key is to limit their feeding of a hyper evolved trader, sometimes called a “market maker”. We also note that a tremendous amount of long-term investor money has left the equity marketplace, according to ICI data, which reported yet another $1.7 billion withdrawal for the week ending February 1st, 2012.

Still, though, we have not taken on the role that for-profit exchanges like NASDAQ and NYSE play in arming these “market makers”. We all struggle every day to tweak and limit our interaction with HFT in a complex and conflicted marketplace. While we all tinker with this process, which is a drain on our resources (big data, policing function, compliance) that takes us away from being traders, we have not called out the role of a marketplace that puts us in that position. And our regulators, the SEC and FINRA, are woefully slow with rule development and enactment. Is there one simple rule and principal we feel that SEC should get behind that can help more than the numerous Band-Aid proposals? Yes.

Regulate what is allowed to be in the exchange data feeds that fuel the “market makers”.

The data feeds include SIP data- like Quantity, Price, Time, and Destination for trades. But as you know, these feeds contain information like revisions and cancels. For everybody. The feeds include ways to tie back executions to orders (remember the “hidden” order disclosure issue?) that today still exist with discretionary order types. When you enter an order to buy 50,000 shares of MCD, using some reserve function, and then revise it up two pennies, and then another penny, and then cancel, the data feeds share that with anyone who pays for the feeds. When you cancel, and the stock you are buying reverts a little, and then you enter your buy order again, the data feeds record and share that. When you cancel again… you get the picture. Your modus operandi is recorded and shared on these feeds, and the “market makers” use it to predict where you will support a stock price, and where they can step ahead and “narrow spreads and provide liquidity”.

Should the exchanges provide data on any feeds that include this enriched information? If DMM’s and “market makers” want to enter and cancel thousands of orders, and step ahead of your displayed and quasi-undisplayed orders, shouldn’t they just be allowed to do that on what is publicly shown and visible? Should they see your cancels and revisions? Why not make it so that everybody just can see what they do themselves in terms of cancels and revisions? Why not make it so that everybody can see public orders (quotes), and the SIP data (Quantity, Price, Time, and Destination)?

Again it comes back to a theme we frequently re-visit: who owns the data – you or the exchanges?

Resolution of this issue by the SEC would have the greatest impact on improving market quality, and would render moot nearly all of the other Band-Aid fixes considered and deployed.