Personally Profitable, Socially Useless

Reading an article on high-frequency trading, I came across the following passage:

That brings us to high-frequency trading (HFT) hedge funds. These funds use computer algorithms—a.k.a.: algobots—to buy and sell stocks at incredible speeds. We're talking milliseconds. The idea is to react to any market news or inefficiencies before actual humans can process them. And it's any idea that has taken over stock trading: algobots make up about half of all stock transactions in 2012 (which is actually down from its peak of 61 percent).

It's Wall Street at its most socially useless. HFT funds aren't allocating capital to where they think it'll be most productive. HFT funds are allocating capital to where they think other people will put it 50 milliseconds from now. It's a tax on everybody else. And it's a tax that has basically no benefit. Sure, HFT funds defend themselves by saying they're increasing liquidity, but increasing liquidity is the last refuge of bullshitters. Just look at the chart to the left from Felix Salmon. It shows that the cost of trading has fallen as our computerized markets have become more liquid, but almost all of the drop happened before HFT. 

Economist Paul Samuelson had it right all the way back in 1957: knowing (or trading) something one second before everyone else is personally profitable and socially pointless.

And it's becoming more pointless now that markets are an algobot battleground. HFT funds aren't trading as much anymore, because there aren't enough humans to trade with.

Hard not to draw a parallel with the recently exposed activities of the likes of Sporting Data, and as I have suggested previously, sooner rather than later, there won't be too many traders left, once it sinks in that the playing field isn't close to even. That Betfair could prevent this, but choose not to, and are thus failing in their stated objective that:

This delay protects both backers and layers and leads to greater liquidity.

continues to be a concern. On this subject, Chicho asked:

Hi Cassini - How does the delay protect me if I cannot cancel my bet while I wait these 9 seconds? Or is there a way to do it?

The answer is that the delay does not apply when cancelling bets that are already placed. As Betfair put it:

Bet placement on in-play markets carries a time delay to allow customers to cancel unmatched orders on the system when there is a change in market conditions.

Unfortunately, if the 9 or 5 or whatever seconds of delay is frequently being beaten by a small number of traders with access to court-side information, (CST - Court-Side Traders) the delay isn't doing what it is intended to do.

The article continued, on the topic of high-frequency traders:

Now, what they do is strictly legal, but that doesn't make the game any less rigged. The Wall Street Journal reports that HFT funds buy early access to data from third-party distributors—everything from corporate earnings to the Philadelphia Fed's manufacturing survey. They're getting the numbers just fractions of a second early, but that's more than enough in the world of high-frequency trading.

There's a big difference between buying early access to public data and early access to private data. The University of Michigan, for example, sells the rights to its Survey of Consumers to Reuters for $1 million a year. Reuters then sells early access to it either five minutes before the public gets it or five minutes and two second before—for the HFT crowd that wants to front-run the frontrunners. It's a horribly un-level playing field (and we should tax some of it away), but, as Matt Levine points out, the University of Michigan might stop doing the survey if they couldn't make money off it.