High Frequency Trading Isn’t Going Anywhere, Ever | 05/02/2014
Just like reality TV. But there’s reason for optimism regardless.
High frequency trading (HFT) is where traders use a combination of hardware and software to see how much someone else is willing to buy or sell a given security for, fractions of a second before the competition does. It’s a bit like being able to bet on a horse race from the future—you already know who’s crossed the finish line first.
Yes it’s dodgy: using computer algorithms traders are technically able to trade in ways that would be illegal if they committed the trade manually. Despite proponents’ claims that it aids in price discovery and market liquidity, HFT has the ultimate effect of skimming profits from the rest of the market. And yes, the rest of the market in all likelihood does include you, even if you’re not an investor, because it includes the pension funds and mutual funds that 401(k)s invest in. The practice has been going on for something like a decade, but because of slow-moving, under-resourced regulators, it’s managed to largely fly under the radar.
That’s changed this year. One reason for the flurry of attention is author Michael Lewis – a Vanity Fair contributing editor famous for his books MoneyBall, The Blind Side (which became Hollywood movies), Liar’s Poker, and The Big Short – has just released a new book, Flash Boys, about HFT. Given his high profile and critical acclaim (the New York Times said “[n]o one writes with more narrative panache about money and finance”), Lewis’s book is refocusing a lot of critical attention on an industry the public didn’t exactly have high regard for to start with.
High frequency traders have also come to the attention of New York Attorney General Eric Schneiderman, who sent subpoenas to more than a half dozen high frequency trading firms within the last two weeks according to the Wall Street Journal:
The attorney general is seeking details about whether the trading firms have secret arrangements with stock exchanges or other trading venues, such as dark pools, that give them the ability to trade ahead of other investors.
Some of the things Schneiderman appears to be focusing on are probably not worth the effort. The practice of colocation for instance, where trading entities place their data centers inside stock exchanges is a hard thing to address and change. Other things like data feeds however, and receiving data before others, are probably not nearly as hard.
The U.S. Securities and Exchange Commission (SEC) also appears to moving towards some kind of a crackdown on HFT, even as the FBI has also opened an investigation into the practice.
Image: Tomas Fano
Bringing a knife to a gunfight?
Given what we know of the culture on Wall St, it’s a given there are bad actors involved in high frequency trading, so it’s disappointing the SEC has made little effort to find them until recent media attention directed its focus. It’s arguable whether the FBI investigators have the resources to do a better job than the SEC, which means it’s hard to know whether the FBI investigation is just for show. Given how specialized this sector of the industry is, it will depend on what kind of hiring or staffing they’ve done. But then again, there are certainly whistle-blowers out there, who are hopefully helping to drive any investigation. And the threat of jail time can be a wonderful motivator for people with highly specialized knowledge who would otherwise be reluctant to share it.
One exchange where HFT is not welcome
One of the stars of Lewis’s book is a Canadian trader called Brad Katsuyama, formerly Global Head of Electronic Sales and Trading at RBC Capital Markets, and arguably the first whistleblower to discover what was going on with HFT. Fed up with what he discovered about the way markets were being gamed, Katsuyama ultimately left RBC to set up a new, more transparent trading exchange called IEX, which allows all traders to compete on a more even footing. A former high frequency trader with a conscience named Dave Lauer was a consultant for the nascent exchange, helping to design the technology systems there.
Lauer had previously worked as a hardware engineer building low-latency equipment for high frequency trading, as a quantitative research analyst for high-frequency traders, and as a contract worker in Goldman Sachs’ tech group. He’s written high-frequency trading algorithms and done mathematical modeling, and arguably knows more than anyone else on the planet about high frequency trading.
The main difference with IEX is really “a focus on transparency,” says Lauer. “You can go to the website and you can see how many shares are trading every day. There’s no other dark pool that does that. And then they give a lot of other statistics in terms of what the makeup is of the order sizes, the fill sizes, on the pool. In March they averaged almost 19 million shares a day, and in April they’ve been between 25 and 30 million a day, so they’re growing really quickly.”
It’s unsurprising there has been pent up demand for an exchange like IEX, but what was surprising was how much the buy side has been a huge supporter: “even Goldman came out and supported IEX,” Lauer reveals. “That was surprising.”
(Matt Taibbi might note however, that the great vampire squid is well known for relentlessly jamming its blood funnel into anything that smells like money.)
What should a healthy market look like anyway?
With partner Chris Nagy, Lauer has launched a new company called Kor which focuses on market structure and lobbying Washington on behalf of all the market participants who aren’t big high frequency traders. As part of this push they’ve launched the Healthy Markets Initiative where they’re trying to push a platform of changes that Lauer says the SEC, along with a pretty broad cross section of the industry, are open to. “There are a lot of technology reforms in there around market data feeds and latency that we’re also pushing,” says Lauer.
For instance, KOR is pushing for the SEC to open up access to data to provide a better understanding of markets, and encourage objective and quantitative research on markets. KOR wants to open up access to MIDAS or Market Information Data Analytics System, and to enhance MIDAS with hidden orders, dark pool orders, and IOCs. “The MIDAS data center is very incomplete,” argues Lauer, “and it’s closed off to everyone, so from an open data and open source perspective, that’s not the way to go.”
Lobbying against the lobbyists
But given that a majority of SEC staff earn a pittance compared to the people they are meant to be regulating—until they inevitably leave and end up working for Wall St—is it really possible to have good regulation of markets?
“Ah… no!” laughs Lauer.
Instead, Lauer and Nagy want to fight fire with fire. They aim to take on the lobbyists of “bulge bracket” firms – companies which are primary dealers in U.S. treasury securities, and which comprise the world’s largest and most profitable multinational investment banks whose clients are large corporations, institutions, and governments. When it comes to market regulation these sorts of firms are currently the only people who have a real voice in D.C.; a major problem as Lauer sees it.
“And so that’s why with Healthy Markets we’re looking to work with exchanges, high frequency firms, buy-side firms, and a few brokers, smaller brokers. All of those firms, they feel drowned out. If we bring them all together, then at least we have a voice that’s as large as the other side.”
Who ate all the pie?
It’s interesting that in the face of all other American industries that have undergone a digital transformation towards greater automation, finance seems to stand alone as having grown its share of the economy. This could mean that Wall St’s share of the economy is overdue for downsizing, given how much of it is now algorithmically driven.
“I think that when you look at GDP and you see that from 1929 to 1988, Wall St and financial services averaged 1.2% and peaked at 1.7%, versus after 1988 where it peaked at 3.3% in 2005,” says Lauer. “To me that’s a dramatic problem, and I think that you would expect the benefits of automation and technology to reduce that or at least maintain in line with historical norms, so I think that’s a big flashing red light.”
Ain’t going nowhere, baby
This does not mean however, that the days of high frequency trading are numbered. On the contrary, “I don’t think it’s going anywhere, ever,” argues Lauer. “I think it’s the new… this is what markets are now. I think that profitability will probably continue to drop, but again it’s questionable how much it’s dropped so far. It’s a very secretive and closed system. But I think that even despite reforms, and the reforms that we’re pushing would change some of the aspects of high frequency trading and change what is profitability in the market, but we have the support of high frequency firms, because a lot of them want to see a more transparent market, they want to see democratization of order flow instead of payment for order flow, and competition over order flow. So I don’t see it going anywhere. I think it will be more highly regulated, that’s inevitable, and that’s been inevitable for a while. What that means is hard to say.”
Just How Violent is American Culture? | 03/21/2014
Like all humans, Americans like to think of themselves as a peace-loving nation: the good guys on the side of freedom and justice. And don’t get me wrong - this country has done a lot of wonderful things for humanity; it’s rhetoric and highest ideals are certainly what other nations aspire to. But despite its ideals, America is also one of the most militarily bristling, savage purveyors of death in history. This is something to bear in mind when listening to the pundits and politicians urging Obama to stop “exhibiting weakness” on Crimea, and start leading from the front in a more forceful manner.
Perhaps you disagree that America is a savage, violent country. Well let’s examine how many people have died violent deaths at the hands of Americans.
Start with annual deaths from firearms in America, of which there are now roughly as many guns as there are people, even if the amount of households with guns in them is declining. Approximately 31,000 people every year die from firearms in America, with the annual rise eerily in tandem with the easing of gun ownership laws.
The family that kills together, stays together
Then there’s the African American slave trade. The most conservative estimate for those killed in the trans-Atlantic slave trade starts at 6 million; however, the likeliest number of deaths falls somewhere between 15 to 20 million (the high end would be 60 million). Hitler of course, one of history’s greatest monsters, killed 6 million Jews. It’s not a comfortable comparison to think about.
Souvenir Portrait of the Lynching of Abram Smith and Thomas Shipp, August 7, 1930
Now let’s examine America’s wars. In all its existence America has only fought two defensive wars that actually threatened its sovereignty. The first was the Revolutionary War of Independence from Britain, in which 8,000 Americans died in battle, (and 17,000 from disease) with about 1,240 British killed in battle (about 18,500 from disease), 1,200 Germans killed, (and over 6,000 killed by disease or accident).
The second was the War of 1812, also with Great Britain, which, among other things, prevented the U.S. from annexing Canada from the British Empire. Roughly 20,000 Americans died. Incredibly, somehow Canada managed to throw off the yoke of British oppression without a shot being fired, although it did take a little longer.
Then there’s America’s Civil War, in which somewhere over 200,000 American soldiers died in combat, with another 400,000+ dying from disease, along with somewhere between 50,000 and 75,000 civilians killed.
Confederate dead at Fredericksburg, Virginia, 1863
In fact, if you add up American military deaths alone over two centuries of its history, the number is somewhere around 1.3 million. You can add in another 500,000 Iraqi civilian deaths to that tally, and I can’t even imagine how many more civilian deaths you’d get up to if you included the Korean War, Vietnam War, Afghanistan War, the Philippine-American War, the Spanish-American War, the Mexican-American War, The War of 1812, World War I and II (a special mention for the 150,000-246,000 Japanese civilians slaughtered at Hiroshima and Nagasaki alone) or all the rest of America’s combat adventures.
The exact moment of detonation at Nagasaki (11:01am, August 9, 1945).
And finally, let’s not forget the the untold numbers of military personnel - and civilians - killed around the world every year thanks to U.S. sales of small arms, mines, tanks, missiles, aircraft, and every other weapon modern industry can conceive of - such as the biological weapons Donald Rumsfeld and the Reagan administration sold to Saddam Hussein in the 80’s, which he then used to massacre Iraqi Kurds with. Now despite not facing a single remotely credible threat of invasion since the Cold War ended (America enjoys allies to its north and south, with vast oceans protecting its east and west flanks), the U.S. spends more on its military than the next thirteen countries combined - all bar one of which are ostensibly our allies - and remains the world’s largest arms exporter.
I don’t think it’s improbable that being one the world’s greatest purveyors of death is having a substantially toxic effect on America, not just in lives lost, maimed, and ruined in America and around the globe, but also in the political functioning of the Republic. The Republican President and former five-star general Dwight Eisenhower famously warned of the dangers of the military-industrial complex at the end of his term in 1961. Yet the world he warned against seems to uncannily match the very world we live in today.
There remains a loud rump of the American electorate to whom possessing the world’s greatest military means every problem or conflict must have a military solution. They are forcefully represented in public debate by the likes of Arizona Senator John McCain, but there are plenty of neocons and chickenhawks in both parties for whom military adventurism is a first, rather than a last resort. It’s hard to overstate the American cultural fetishization of guns and military force.
But we are now living through “the disastrous rise of misplaced power” accumulated by the various defense bureaucracies Eisenhower specifically warned against (the CIA and NSA leap to mind). We have “let the weight of this combination endanger our liberties [and] democratic processes.” We have “taken these developments for granted”. And if “only an alert and knowledgeable citizenry can compel the proper meshing of the huge industrial and military machinery of defense with our peaceful methods and goals, so that security and liberty may prosper together,” well, we have failed in being alert and knowledgeable too.
“Disarmament, with mutual honor and confidence,” Ike pleaded, “is a continuing imperative. Together we must learn how to compose differences, not with arms, but with intellect and decent purpose.”
America has a military that’s the best in world at breaking things and fcking shit up. But the anomalous cases of Germany and Japan aside, America hasn’t shown the same skill in “nation building.” Any time you go to war, both sides lose, because people - and invariably innocent people - die. So can we please stop constantly trying to rush to war with anyone who isn’t actually directly threatening America’s citizens or territory?