No, Arthur! We Are Not All High Frequency Traders Now


No, Arthur! We are not all high frequency traders now.  We say this in response to a WSJ op-ed written by Arthur Levitt and Burton Malkiel titled “We’re All High-Frequency Traders Now”.  Levitt and Malkiel wrote:

“It’s easy to stir up fear over such trading activity, but most stock-market volume is conducted over these high-speed networks. And whether you’re buying 100 shares of a stock or 100,000 shares, you directly or indirectly participate. We’re all high-frequency traders now.”

We think Levitt and Malkiel are confusing high frequency trading with low-latency connections. The “frequency” in high frequency trading means that you trade and quote frequently – very frequently. The retail investor buying 100 shares is not trading and quoting frequently.   Levitt and Malkiel also conveniently forgot to mention that most high frequency traders try to minimize risk by reducing their net asset position to zero.  The retail investor that Levitt and Malkiel claim is an HFT is actually holding that position in inventory and taking risk.

While we take issue with this obvious sleight of hand that Levitt and Malkiel tried to pull off, we actually do find ourselves agreeing with some of what they say in the second part of their op-ed. Levitt and Malkiel state:

Dozens of complex venue-access fees have created perverse incentives for brokers to route trades that benefit them at the expense of their customers. Moreover, increased reliance on speed combined with much greater fragmentation and complexity have created systematic operating risks, as evidenced by the increased frequency of market failures over the past several years.”

This is and has always been the central issue for us in the market structure debate. Unnecessary fragmentation has created artificial arbitrage opportunities that do not help the price discovery process.  Levitt and Malkiel make this excellent fragmentation analogy:

With each newly established market, the price of similar assets can change slightly. It’s like the difference between observing something using a telescope and then looking at the same object using a kaleidoscope: You can still see the same thing, but the image is fractured into a million similar, less clear images.”

We do, however, find it very odd that Arthur Levitt is now complaining about market fragmentation. Is this the same Arthur Levitt who in a 1999 speech ​ defended his Commission against critics who claimed that market fragmentation was dangerous by saying:

The fact is, multiple markets have existed since the earliest days of trading. And we have long believed that different market centers must be connected. Today, is there “fragmentation” in the sense that there are separate, isolated markets with reduced liquidity in normal trading hours? I think not. But is there “fragmentation” in terms of multiple pools of liquidity competing for orders based on transparent quotes and prices? Absolutely.”

We’re not quite sure why Mr. Levitt is choosing to pivot now in the market structure debate.  But then again, we’re not quite sure why Goldman chose to pivot.  We do believe that Levitt, an adviser to KCG and Goldman, is a savvy political operative that stays ahead of the curve.  Maybe he sees regulations changing and is doing his best to get out in front of them.  Or maybe, he is choosing to distance the firms he advises from the Flash Boys fallout.

We really don’t know.  But we are thrilled that the central issue of fragmentation is being spotlighted now.  Fix this and the market will fix the rest.