The Smoke Screen – Round Two

I last wrote about High Frequency Trading (HFT) in June of 2013 here when the buzz was about news agencies releasing data to the HFT machine readers early. The story then focused on the evil news agencies seeking profits. Back then the I noted this as a deflection away from the real issue of HFT. The crooks were sending the police to investigate someone else. The real issue was not an early release of news allowing a HFT system to beat you to the punch. They could beat you to the punch if they gave you a 15 second lead. The real issue was and continues to be HFT front running your trade. They see your order before it hits the order book and step in front of you. That is what can cost you money.

But alas my assessment of the situation was wrong. The new book by Michael Lewis is focusing a bigger spotlight on an issue My friends Sal Arnuk and Joe Saluzzi at Themis Trading have been yelling about for years. They even wrote a very good and readable nuts and bolts book about it Broken Markets 2 years ago. But as I noted the renewed focus is also showing that my assessment was wrong. When the HFT firms deflected the SEC to investigate the early releasers, it was not the crooks sending the police to investigate someone else. With the latest blathering out of the SEC it is clear they are not the police trying to protect and serve. At least not in the way your local men in blue do. They are more like police of the post prohibition era, in the pocket of Nucky Thompson or Al Capone. The HFT firms are not afraid of the SEC dismantling their front running operations. They are working as if they are bought and paid for.

It is unfortunate that the initial focus following this new engagement with HFT was set to the tone of ‘the markets are rigged.’ They are. Using limit orders and trading less frequently you can get around a lot of that. Being rigged does not need to hurt the little guy on a trade execution. Do your homework and pick your levels and stick to them. In this way your trades are not impacted, at least not as directly. You may get less fills due to the front running, so there is opportunity cost.

With the FBI getting involved this is sure to end in a series of arrests and jail time (facetious). I Believe it was Barry Ritholtz that most recently brought the term skimming to the discussion. This is what is hurting the big guys. Not so much on one trade but collectively over all trades. The seemingly unprofitable business if sub penny trading, made profitable by the maker/taker model, eating just a fraction of everyone’s trades. The big firms (read mutual funds, pension funds) cannot put in a limit order for 1 million shares. They are chewed up by these HFT algorithms. But hey, the managers of these are using other peoples money and most get paid for size not performance, so who cares? You should. Where HFT does not have to impact your trades it does impact any trades others place for you. This adds up to a lot over time. Let’s see if this is where the FBI focuses. Or if the SEC changes its tune. It would have been much more impactful Michael to write your subtitle as ‘how computers are steal everyone’s money’.

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