The US Stock Market – Where the Big Dogs are Alpha-less
Haim Bodek has published a white paper on his website that you should all read, titled HFT Scalping Strategies. It outlines in a somewhat general way the concept of HFT Scalping Strategies, which serve as a cornerstone of the overwhelming majority of HFT strategies deployed in the market place, including but not limited to rebate arbitrage.
The scalping strategies are “alpha-less”, meaning that they are microstructure oriented – they use features such as the multitude of order types and the low-latency sold by the exchanges in order to gain queue position in the limit order books, as well as the “insurance” against being adversely selected. According to Bodek:
Its core intent is, on every round trip trade, to step ahead of supply-and-demand imbalances evident in market depth, and to capture a micro-spread by closing on the other side for a tick or to scratch out by closing on the same side, both of which are favorably subsidized by rebate in the maker-taker market model that is currently prevalent in US equities.
The HFT programmers are always trying to “win or scratch”. Win means capturing a 1-tick (penny) spread, where scratch means an exit at the same price a trade is entered. Money is made regardless, as the stock exchange rebate structure not only subsidizes the “provision of liquidity”, it provides for guaranteed economics. Firms can enter a trade for a greater rebate than they exit. Bodek perceptively notes:
This simple win-or-scratch strategy should not be profitable in a competitive, fair and orderly market, where competition for queue position and favorable execution would presumably be saturated.
Are HFT firms doing anything illegal by focusing on these alpha-less strategies? No. Are stock exchanges doing anything illegal by providing these firms order types and means to maximize the profitability of their “best customers’ algorithms? No. Is it a good development for the stock market that this video game is exalted at the expense of investors, and the true exchange of risk and capital? No. Does the SEC understand this? No – they see nothing wrong with the system, as anyone can embark on these strategies, understand the usage of thousands of different order types available by the stock exchanges, and buy their colocation.
The SEC does not understand, as you and Haim Bodek all do, that having the ability to play this video game, while available to all for a price, is only useful if you are actually playing that game. In other words, it is nice that we can understand the thinking of the algorithms employing “alpha-less” strategies, but the tools are of little use unless you actually play the game. Guaranteed economics are a leakage and tax on all investors, which is why we have advocated for several years that the core of fixing our Broken Markets is the elimination of payment for order flow, and the guaranteed economics of the maker-taker rebate pricing system.
Oh yeah… it’s Election Day. You know what to do – vote early and vote often!