High frequency scapegoating

The Futures Industry Association held a panel on high frequency trading on Thursday in Chicago titled, “Perspectives on High Frequency Trading and its Overall Impact on the Market.”

The three practitioners on the panel did their best to dispel some of the myths surrounding high frequency trading helped by moderator John Lothian and had a sympathetic audience of members of the Chicago trading community but for those who view this practice as potentially disruptive, I am not sure they gained any believers.

Lothian presented a list of quotes — some fairly ridiculous — from media coverage of the space along with the correlated “myth.” Lothian did touch on the point that what these traders are doing is similar to what trades have always done — trade faster than the other guy, anticipate congestion levels and perhaps where stops may be lurking in the market and take advantage of it. Basically, finding an edge and exploiting it.

But when pressed, they had difficulty stating exactly what they do. In fact one of the panelists described HFT as trading done at high frequencies.

It is true that there are many different strategies than come under the broad umbrella of HFT. Don Wilson, Chief Executive Officer, DRW Trading Group volunteered that simple intercommodity spreads are a common HFT strategy. In the options world some strategies attempt to take advantage of maker taker pricing convention but the panel indicated that is a small percentage of professional traders. And there is nothing wrong with that. If you create rules with different price levels, traders will try and use it to get an edge. Perhaps that is the best definition of what they do, ‘attempt to get an edge.’

Richard Gorelick, Chief Executive Officer, RGM Advisors said that nearly all the numerous studies of HFT invariably show that HFT either has no impact on market volatility or that it acts to dull volatility. This makes sense as active short-term trading eats up volume and makes it easier for others to execute size without having a huge impact on the market. Hundreds of traders scalping in a market allows larger players to get off their size without it having a huge impact on the market. That is a good thing.

Wilson, said, they aren’t competing with institutional and retail traders; they are competing with other low latency traders. “It is not a new thing, it is a new way of doing an old thing," he said.

They also argued that low latency and speed are not enough to guarantee profits. The strategies must be sound.

While it is understandable a group of high frequency traders get together to commiserate their fate of being misunderstood and unfairly maligned — hearing some of the more illogical charges, I sympathize — it does not educate those that would scapegoat them.

They have a perception problem and while many of us who see what they are doing as simply replicating what traders have always done just in the new trading environment, those that don’t understand include some regulators who can affect their business. And make no mistake, all those criticizing HFTs are not confused trading neophytes, there are some pretty knowledgeable people who believe they have an unfair advantage and are harming the markets.

It all goes back to a question I asked: You described some of the misperceptions but not precisely what you do. What do you do?

They need to do a better job of answering that question if they don’t want the regulatory hammer to come down on them. And the exchanges need to do a better job in explaining how collocation works and any other means to connect to an exchange match engine that can be viewed with skepticism. Who has access to it, how different market players access it, what is the cost. There is a pretty consistent opinion in many quarters that exchanges are giving these folks an advantage because they account for so much volume at the expense of other market participants.

If this is not true, then they need to do a better job of explaining why.

About the Author
Daniel P. Collins

Editor-in-Chief of Futures Magazine, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange. Dan joined Futures in 2001 and in 2005 he was promoted to Managing Editor, responsible for overseeing all the content that went into Futures and futuresmag.com. Dan’s incisive reporting and no-holds barred commentary places him among the most recognized national media figures covering futures, derivative trading and alternative investments.

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