Look, I'm no fanboy of high-frequency trading (nor a participant), but as an outside observer, I think I need to clear a few things up for us common folk.
First, the legitimate aspects of HFT as I understand it:
- It's not a crime to buy really fast hardware and locate near stock exchanges to get the fastest quotes routed to you
- It's not a crime to execute ways of buying/selling securities that result in profit, even if it's unconventional
- "Algorithm" has become a bad word, but even deciding to buy companies based on their P/E ratios is an algorithm folks. Just because HFT algorithms confound people doesn't mean they're illegitimate.
- Even if the "flash-crash" was induced by HFT players, this too is not a crime. It just gets a lot more public attention since it was a dramatic event. Large-scale problems or policies that fleece people seem to be swept under the rug much easier.
Second, the negative aspects of HFT:
- People playing mind games with pension funds with thousands of fake bids. This sounds a lot like pump-and-dump or other games that hedge funds use (premarket manipulation for example).
- Front-running. If the whole point of upgrading your technology is to see bids ahead of others and make decisions based on this, something just doesn't sound right.
- The high-delta movements in stock prices every now and then cause panic and some traders to go out of business on that day. In every case, the stock prices seem to recover within minutes. However, there's no reason for these to make national headlines since most people don't day-trade. But when big money loses money to these HFT players, they cry and pout and it makes headlines.
However, the point of my post isn't to deconstruct the pros an cons of HFT. It's just that as person with an appreciation for basic math, I've heard way too much nonsense from financial advisers and market "experts" on their opinions on this style of trading and though I'd share a couple of basic observations that go against their claims.
The #1 piece of bad advice: Don't even try to beat the computers by timing the markets
This has to be the most common, idiotic advice you hear. If you take out the "beat the computers" part, it's fairly reasonable advice - that is, don't even try to time the markets, as most people don't have the ability to do this consistently. But what makes this advice so idiotic is the total disregard for trading time frames and the fact that you're not even playing the same game they are.
So what does this have to do with basic math? Well the basic fact of the matter is that high-frequency trading attempts to make milli-second decisions on momentary prices, not large-scale decisions. In other words, a trend could be perfectly intact, but instead of a certain pattern of choppiness previously dictated by individual investors who sold for various reasons, they've been replaced by short-term price action dictated by algorithms. What's funny is that the whole point of many of those algorithms is to try to emulate/predict price action based on human behavior, but in the process taking the manual and emotional aspects out of trading. So at the end of the day, you as a human could potentially spot HFT behavior and beat them at their own game, if not on a milli-second scale, at least on a hourly to daily basis.
To say that HFT manipulates the overall market is kind of like a new-age version of the old argument that said that "traders" were bad for the market because they didn't simply buy-and-hold and reward fundamentally sound companies. As we know, that old argument has long been debunked as company fundamentals eventually dictate where a stock goes. The world, however, isn't perfect or perfectly predictable (much to the disappointment of efficient market theorists), so many short-term opportunities do arise for traditional and HF-traders alike.
So I say that instead of banning HFT- and the only reason to do so seems to be motivated by traditional Wall street types feeling pain during large price swings (individual investors don't matter of course) - embrace it as a legitimate form of trading and adopt to it.
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