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The High Frequency Trading Debate Gets Down And Dirty

Courtesy of Tyler Durden

A major piece by Paul Farrell of MarketWatch “HFT-Quants beat Lazy Portfolios in the ‘Singularity‘” blasts virtually all aspects associated with HFT, contrary to Goldman Sachs’ most recent vocal defense on the topic (more on that later). From Paul’s piece:

No wonder “too-stupid-to-fail” banks prefer gambling with HFT-Quants over helping small commercial banking customers. This is their cash cow generating future earnings: As Forbes recently put it in “The New Masters of Wall Street” “… even as financial markets collapsed last year, high-frequency traders collectively enjoyed $21 billion in gross profit” while “some high-frequency traders are sending out 1,000 orders a second.”

And Farrell points out the dramatic divergence that has occurred under everyone’s noses over the past five years, in which HFT (ab)users now enjoy a “heads we win, tails we win” market monopoly, while retail is stuck with the opposite trade.

Worse yet, if America’s 95 million individual investors do try to play this new game against these HFT-Quants, they will lose big.


In the Forbes piece Liz Moyer and Emily Lambert warn: “One eyebrow-raising reality is that a big chunk of high-frequency profits derive from jumping into markets before small investors can — in the high-frequency world, the 20 milliseconds it can take quotes to travel from Chicago to Nasdaq’s market site in New Jersey.” The HFT-Quants are always way ahead of you, skimming your money.

The inordinately profitable role of HFT, as many have pointed out, is simply too big to ignore:

Last year Wall Street banks were virtually insolvent. Taxpayers stimulated them back from the dead. Now, thanks to the proliferation of HFT-Quants, Wall Street’s again racing at hyperspeed, gambling with the money it conned from taxpayers, using it to skim more from clueless investors. First the Fed and Treasury, now Wall Street’s “Too-Stupid-To-Fail” banks are stealing from Main Street’s “Too-Dumb-To-Stop-Trading” investors.

Farrell, in borrowing a term penned by visionary Ray Kurzweil, has coined the definition of a “Singularity” to explain where in the technological continuum the various subtechnologies that make up what is known as high frequency trading, belong:

Forget 2045. Reality’s now moving at warp speed thanks to the new HFT-Quants. The “Singularity” is not “near” … it is here … it is now … it is today. And in this new “Singularity” the HFT-Quants no longer trade as they did in the old stock exchanges even a few years ago. They’re light-years beyond not just Main Street, but also Congress, the SEC and Fed. In the immortal words of Star Trek’s Captain Kirk, they’ve “gone where no man has gone before.”


HFT-Quants virtually created this “Singularity” where computers exceed human intelligence, where the quants’ superpowered math algorithms far exceed the primitive human intelligence of the average Main Street investors. And where Main Street investors are called “irrationals” by behavioral economists, and gamblers and con men call us “a mark.”


Forbes bluntly put it this way in a sidebar: “Trading for Dummies” “The role of sucker on Wall Street has traditionally been played by retail investors.” That’s you.

Stop Day-Trading: that is the simple solution to prevent the HFT monopoly from skimming hundreds of millions, if not much more, of pennies daily from naive retail investors who join the herd every day as per CNBC’s admonishments that if you leave your money in your bank account you will be broke and presumably branded a traitor.

Forbes offered some sound advice: “If every penny counts for you, there are still ways to avoid being the dumb money in a trade.” The usual tips: Streaming quotes, limit orders and “pay attention to premarket action.”


But in their fourth “Trading for Dummies” tip they really show their cards, telling Main Street investors something we’ve been preaching for years: “Don’t day-trade: It’s a losing game to try to make money chasing momentary market inefficiencies. Too many pros with too much computing power are already at it. Instead, decide on a set of long-term investing goals and trade infrequently to achieve them.”

And more:

Get it? Never trade. It is a loser’s game. Remember that famous research studies by two University of California finance professors, Terry Odean and Brad Barber. Their bottom line: “The more you trade, the less you earn.” Why? Transaction costs, taxes and bad decisions always kill returns. Today, you must add a fourth element to this loser’s equation, an unbeatable opponent, the HFT-Quants.


Unfortunately, Main Street’s full of suckers, as a recent AP wire story proves: “Investors are still trading common shares of Fannie Mae, Freddie Mac and AIG by the billions, even though analysts say their prices are almost certain to go to zero. All three are majority-owned by the government … ‘zombie’ companies that technically are alive, until the government takes them off life support” … and wipes out all shareholder equity.


Meanwhile, every 20 milliseconds “HFT-Quants” are taking another “too-dumb-to-stop-trading” little investor trapped in the illusion that Fannie, Freddie and AIG will “be worth something, someday.” “HFT-Quants” don’t think long term. Their algorithms think in milliseconds, just enough time to skim more money from all the ‘dumb money’ out there.

And here are the advantages that differentiate the smart, top-tiered HFT market players, from everyone else in the new marketplace battleground according to MarketWatch:

  • Real estate. “Infinium Capital is the biggest market-maker in natural-gas futures and runs its computers in 100,000 square feet near the Chicago River.”

  • Servers and screens. “The core of its operation is 40 racks of servers overseen by quant traders who man up to a dozen screens each.”

  • Energy. “Infinium’s operation runs on a piece of the public electricity grid backed up by two separate power substations and 196,000 pounds of batteries.”

  • Backup power. Still the system’s “not safe enough. Infinium is paying to install a 2,000-kilowatt diesel generator just in case.”

  • Data transmission. “Infinium taps into the CME Group’s computers … via dedicated fiber-optic lines capable of transmitting up to 5,000 orders per second with a lag time of no more than 10 milliseconds.”

  • Tech centers. The competition is pushing to be as “close to securities exchanges as possible” to cut transmission time. “Six square feet of space in the data center where the big exchanges also house their computers goes for $2,000 a month.” Many trading firms “spend 100 times that to house their servers … NYSE plans to open a 400,000-square-foot tech center in New Jersey.”

And the conclusion recap:

In this new reality “they are able to scoop up a spread of a tenth or a hundredth of a penny per share thousands of times a day” on billions of shares traded every day.


Only a fool would bet against the new HFT-Quants or challenge them out there on “The Singularity” battlefield, where “the high-frequency boom is reshaping securities markets everywhere.” Don’t trade, stick with a Lazy Portfolio of no-load index funds.

Yet it would be a one-sided perspective if the other point of view was ignored, which is why we present Rosenblatt Securities massive, 34 page long, spirited defense (which amusingly takes a jab at the “eruption of blog postings…often breathless in tone and accusatory in tenor”) of why HFT is so great for everyone involved, or at least for those who provide “liquidity” while tricking those day trading gamblers who just need to get their fix…one more time. Even if it means ongoing, recurring losses. And while the entire memo is below, the following chart should quickly indicate why the current “breathless accusations” of HFT stand to generate massive revenue losses for a product that now dominates virtually every vertical of the equity markets:

Full report for those who have had their caffeine injection:

Yet even spirited defenses deserve their fair rebuttals, and we present one prepared by the principals of Themis Trading:

HFT defended in 30-something page Report BY HFT Sponsor.

There is report being passed around by one firm , who self-admittedly counts ” a handful of HFT firms as sponsored access customers”. Firstoff, anyone want to guess what % profit for the “agency broker” these “handful of HFT firms” account for?



He dismisses our concerns with HFT (”a blog post here, a white paper there”) as not meaningful. Senators, hoardes of buy-side traders, traditional broker dealers, and the longtime owners of our financial systems (ie John Q Public) disagree. I actually find it amusing to note the lack of trading experience, and lack of long term perspective, among the most vocal critics of those who question HFT. In addition we are amazed that every defense of HFT that we see in mass media is raised by either those who work in HFT, or are a consultant to HFT, or a technology provider to HFT, or an exchange courting HFT flow, or someone selling access to HFT.



As for us we have no stake in this debate. Actually you could argue that we should keep quiet, as the more sinister a market  environment created by HFT, the more  value we can add to the trading equation, and the more successful our firm will be.  So why are we raising Cain? We don’t think this market environment is healthy, and we plan on being around for the long haul. It would be nice if the market were not blown up in the interim.



Our concerns our summarized here: http://advancedtrading.com/algorithms/showArticle.jhtml?articleID=220300593



And we think we can be more succinct than their 34 page defense:



Is liquidity in the already-liquid top 100 names in the market, and sub-penny price improvement, worth creating a multi-tiered and opaque market self governed by the same folks, who have already time and time again, demonstrated their lack of ability to restrain from highly damaging excess?



One more point that should tell you everything you need to know. Notice the hoardes of talent poaching and defections from traditional brokerage firms and exchanges (not typically underpaid folks to begin with) to HFT firms?



I sure hope rationality trumps greed by the time this is said and done.

At the end of the day, someone is right and someone is wrong. With the SEC now actively doing a thorough investigation of the entire market landscape, we and everyone else can only hope for a fair assessment of just who is it that profits on the back of those naive day traders who day after day have to battle with the “HFT-Quant Singularity.” And, as Zero Hedge discussed previously, Mary Schapiro’s reputation and legacy is at stake on this one: a mere check mark or stern warning will no longer do, as there are much higher political interests involved. We will continue covering this debate through whatever conclusion it may ultimately reach.

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Rosenblatt.pdf 4.62 MB

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