High frequency algorithmic 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 asked our experts if high frequency algorithmic trading is actually making markets more efficient, or is it simply pushing the smaller trader out of the markets?
Here's what they said.
Like Taylor Swift says, “Haters, gonna hate, hate, hate." We have a lot of sympathy for the smaller trader that has been complaining about the HFT trade messing with the day trade action, but in oil we’re seeing a different take. I see many physical oil traders that would love to dip in and out of the market to pad their books, but they are stepping away from what they don’t understand.
I’m seeing more of these “paper traders” just tearing up the playbook and heading over to the OTC markets. Granted nearly all of the OTC trade is still cleared, so exchange volumes are looking good, but they’ve moved away from the point and click play. The voice brokered market is finding a revival, but it’s still not big enough to fit all of the displaced floor brokers.
Carl Larry is the president of Oil Outlooks and Opinions LLC. He provides daily oil market guesstimates with a dose of pop culture.
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Matt Weller @MWellerFX
I tend to take a rather stoic and pragmatic perspective on these types of questions; after all, regardless of the effects of high-frequency trading, it is here to stay, an indelible aspect of the trading landscape that is unlikely to change any time soon. In many ways, spending time debating whether it is “good” or “bad” is akin to debating the relative merits of Blu-ray technology vs. HD DVD.
That said, I see high-frequency mostly beneficial force that generally improves the efficiency of markets. Certain practices, including offering colocation facilities to the highest bidder and so-called quote stuffing to slow systems down, should be heavily regulated or banned in my opinion.
Matt Weller is the Senior Technical Analyst for FOREX.com. He contributes regular updates on various currencies and commodities throughout the day.
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No, and no.
First, HFT cannot make markets more efficient if it only extracts value from order flow that would exist in its absence. HFT is a retailer. At least a traditional retailer's markup is restricted by the invisible hand of competition. In that model, retailers improve their product to justify its value compared to the competition. Not HFT, which offers no value that the market could not deliver otherwise. Marking-up each sale only diminishes the value of the "goods" that the HFT is reselling.
Second, while a number of traders may be repulsed by HFT, their total is likely offset by those attracted to the volatility encouraged by HFT. However, those totals of traders pale in comparison to the potential totals of investors that HFT may inhibit from participating in the markets.
Rod David develops analytical techniques that are designed to efficiently identify targets and turning points for any liquid stock or market in any time frame. He primarily analyzes S&Ps, generating several round-turn candidates daily.
To begin a discussion about high-frequency trading, we need to define the market complex because high-frequency trading has had a different impact on various markets such as futures, stocks, options or cash markets.
I teach courses at high-frequency trading firms around the world and it has provided me the opportunity to see trends and technology changes in the high-frequency trading space.
I do believe that high-frequency algorithmic trading can add liquidity and make markets more efficient by creating tighter bid ask spreads. This is particularly noticeable in the futures markets. For example, the Globex platform at the CME Group matches buy and sell orders on a first in first out basis. That means if I pushed the button before an institutional trader puts in an order, I will be filled first before the institutional order. It is a level playing field. All orders for markets traded on that exchange can only be executed on that exchange. This is an advantage because it makes orders transparent.
In the equity world, an order can be executed on 13 equity exchanges and over 50 Alternative Trading Systems. This is the result of the 2005 SEC National Market System. The intentions were well intended to promote competition, but it created unintended consequences because there are a variety of places an order can be executed for a particular stock creating potential vulnerabilities.
In the options market, high-frequency trading is a very small part of the order flow. This was also true in the cash currency markets a few years ago but it is steadily increasing.
If a trader is trying to trade the difference between the bid and ask, they would be competing with the high-frequency trader and it would be very difficult and expensive to do so.
However, most private traders are not trading for the difference between the bid and ask but rather they are looking for a larger move and the high-frequency trader provides them with the liquidity to enter and exit their position.
Dan Gramza is President of Gramza Capital Management Inc. and DMG Advisors, LLC. He provides daily market updates from around the globe on subjects ranging from the Nasdaq and currencies to crude oil and grains.
This is actually a two-sided question. There are both changes to how the platforms traders use perform under different circumstances, and how the advent of so much HFT and program trading has affected price movements.
To tackle the latter aspect first, it is not so much whether HFT is shoving the smaller trader out of the market. It is more so a matter of whether the smaller trader has learned to adapt to the admittedly different meter and tempo of trends. Whereas there used to be regular intraday or full day minor corrections, markets now experience more multi-day, one way-swings.
The smaller trader’s ability to enter markets on a short-term correction has been significantly diminished. And that affects both psychology and risk management. Successful small traders have adapted. As one example, they know they might need to ‘reach’ to enter markets after a gap opening. In the ‘good old days’ the received wisdom was to always wait for a short-term retest of the gap. But that just doesn’t happen very often any more.
On the issue of how platforms perform, there are complaints that HFT only creates ‘phantom’ liquidity that quickly evaporates when volatility increases. Yet that is most likely only an exacerbation of tendencies which were always there.
Markets always get a bit thinner when they are volatile, as less than committed bids and offers get pulled. I've witnessed this for over forty years. This extreme dissection of the exact levels of liquidity, and whether HFT actually increases or decreases it is the worst sort of financial industry navel gazing. Ever since algo trading mishaps have driven the occasional outsized swing that freaks out the public, every big swing gets over-analyzed.
Review and improvements of system protections and circuit-breakers is always necessary. Yet we also need to allow that part of the attack on HFT might be investors (and their elected representatives) looking for scapegoats to explain away their overly sanguine view of intrinsic market risk factors. They're always happy until the market goes down. We rarely hear anyone complain about upside volatility when the equities explode.
Alan Rohrbach is Lead Analyst and President of Rohr International Inc. He is an international equity index, interest rate and foreign exchange trend advisor. His forte is ‘macro-technical’ analysis of how fundamental influences blend with technical aspects to drive trend psychology. Clients include international banks, hedge funds, other portfolio managers and individual traders.
As an industry participant for over 20 years—and as a trader and broker—I have had a bird’s eye view of the changes that have resulted from the HFT revolution. I can conclusively state with absolute conviction that the liquidity of the marketplace has been harmed dramatically by the inequalities in the market.
Furthermore, the 'market makers' that have traditionally been the back bone of price discovery are being driven out in droves with many of those once large liquidity providers now unable to perform this valued function. One only needs to look to the past view days for further evidence of this liquidity vs. volume argument. The CME has recorded record volumes that past several days with the radical swings the market has produced.
That record volume did very little to provide actual liquidity as we saw normally very liquid markets like the S&P futures and U.S. 30 year bonds price ranges go far further than they ever would have under similar circumstances prior to the HFT phenomenon (nearly 6 handle range in the bond market!!).
The result was fairly obvious as we saw massive gaps in the pricing with what can only be termed as a slew of mini flash crashes that the average trader had zero price information on. The more conditions we see like these (and it has become more and more frequent, pun intended) will continue to lead to the mass exodus of the middle market maker thus drastically increasing the volatility of the market place and, in fact, reducing the markets efficiency.
Tory Enerson is a senior market strategist with the Zaner Group in Chicago, an Independent Introducing Broker. He has been in the futures industry for over 20 years.
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