From the May 2014 issue of Futures Magazine • Subscribe!

High frequency traders: Fall guys or felons?

High frequency trading has been a focus of discussion and controversy in the financial markets for some time, but the release of Michael Lewis’ book “Flash Boys: A Wall Street Revolt” has amped the level of debate up a few notches.

We pose a series of questions to some industry experts and attempt to separate facts from myths regarding high frequency trading. The stakes have risen and it is important people understand what high frequency trading is and what it isn’t.

Futures Magazine: There has been a great deal of confusion and fear over high frequency trading (HFT). What is your one-sentence definition of what HFT is? Do many people understand what it is?

Peter Nabicht: The name “high frequency trading” is self-defining. It is simply trading with a higher frequency relative to other market participants.  

Lately, the phrase has been given so much implied meaning. “HFT” has become a catch-all phrase that is mostly used by people to label specific activity that they do not like or find to be predatory. There are bad actors in the market, at any frequency and speed, but their actions don’t define HFT. We shouldn’t ignore the many benefits HFT brings to the market, such as tighter spreads, more liquidity and efficient, fair prices.

Irene Aldridge: High frequency trading is a class of intraday trading strategies that electronically model operations of traditional human brokers, including market making, order routing and trading book risk management.

Keith Ross: HFT is market making with software. Most misunderstand, like they misunderstood the specialist.

Spalding Hall: Entities paying for access and then using speed to see orders/trades (that slower traders do not have access to), which allows them to make a guaranteed profit on a trade.

FM: Michael Lewis called the U.S. equity market “rigged.” Do you think it is? If so, is HFT the cause?

PN: The market is not rigged and saying so is gross hyperbole. It wrongly implies that there is a vast conspiracy against the end investor and does more to hurt confidence in the markets than anything else said in a while. Lumping all behavior together and labeling it as all bad does a disservice to the book’s readers and is too simplistic a take on a complex topic. However, Flash Boys brought complex market structure and broker conflicts of interest to the general public. The dialog coming from the book will continue longer than the hyperbole.

IA: The U.S. markets are more transparent and fairer than they have ever been, and are presently on path to become even stronger. Interest in the strength of America’s financial markets has never been stronger. Michael Lewis is considerably off base in his perceptions and his book will have little lasting impact to how markets work today. He comes across very much still stuck in the 1980s, the last time he actively participated in the financial markets by his own admission, and the time when Lewis [describes] unfair trading practices in detail in Liar’s Poker.

KR: The market is not rigged. It is highly efficient and hugely competitive. Fallout could be that politicians try to fix it and don’t know what they are doing.

SH: Yes. A guaranteed profit is the definition of rigged. The fallout will be the loss of “real” money and investors.

FM: Is Lewis’ characterization of HFT correct or is something missing? If so, what does he fail to explain?

PN: Lewis’ characterization of HFT is far from correct. He describes a few bad practices, which if anything is a small minority of trading activity, and ignores the vast amount of HFT activity, which is beneficial to the markets and investors. Lewis wrongfully gives the impression that all HFT is predatory.

It isn’t that he completely fails to explain properly, he just fails to do so clearly and effectively. Lewis writes: “And anyway, it wasn’t high frequency trading itself that was pernicious; it was its predations.” The problem is, he buries this important differentiation in the middle of a paragraph 170+ pages into the book and fails to further explain HFT.

KR: Analysis is wrong, what he is missing could fill another book.

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