The New SEC Director of Trading & Markets
Earlier this month the SEC announced the appointment of MIT Professor Haoxiang Zhu as the new Director of Trading and Markets. While we personally don’t know Professor Zhu, we think his appointment is an excellent choice based on some his past research on equity market structure topics.
One paper from 2017 that stands out to us was “Back-Running: Seeking and Hiding Fundamental Information in Order Flows”. Here is the conclusion from that paper:
“Back-runners start with no innate trading motive but observe past order flow information of fundamental investors (or equivalently, noise traders). Order flow information allows back-runners to partly infer the information of fundamental investors and exploit it in subsequent trading….Under reasonable parameters, the total value earned by back-runners is 5–30 bps of retail dollar volume and the total value earned by institutional investors is 70–80 bps of retail dollar volume.”
Professor Zhu explained this further in a MarketWatch article :
“It’s difficult to execute large trades when HFTs deploy sophisticated pattern-recognition software in search of order-flow information that they can use to their advantage. When an asset manager unintentionally leaves footprints that tip its hand to these HFTs, the price is often impacted to the detriment of the asset manager.
We find that asset managers have a powerful weapon against HFTs that exploit order flow information: Randomness.
The takeaway from our research is that asset managers can outfox “back-running” HFTs by making their trades appear random to avoid detection. Although it may seem to be an inefficient way to complete a large trade, randomization will benefit investors in the long run by limiting the back-running behavior that increases investors’ price impacts.”
As you know, we at Themis have been talking about this concept for years and employ this tactic in our daily trading. We often bounce around numerous exchanges and dark pools with the goal of not leaving a footprint. For example, sometimes we’ll be resting mid-point in IEX, other times we’ll post a displayed order with a reserve quantity on a major exchange. The goal is maximize volume while minimizing transaction costs while never leaving a quote or trade pattern that could be observed by an HFT.
Some other noteworthy market structure papers authored by Professor Zhu include:
In addition to his equity market structure research, Professor Zhu previously served as an academic expert for the US Commodity Futures Trading Commission (CFTC) and the Bank for International Settlements (BIS), and is currently a member of the Federal Reserve Bank of Chicago’s Working Group on Financial Markets. While we were sad to see Brett Redfearn leave his post as Director of Trading and Markets, we’re glad to see that SEC Chair Gensler appointed a market structure expert to this role.
Congratulations Professor Zhu, we’re looking forward to seeing your work at the SEC.