Flash Back

The issue of High-Frequency Trading (HFT) came to the fore with the Flash Crash of 6th May 2010 and has since drawn further attention and debate with proponents saying that the practice adds liquidity to the markets while opponents argue that the practice leads to front-running, market manipulation and insider trading. These activities are now under investigation by the Federal Bureau of Investigation, coincidentally (or perhaps not so coincidentally) announced the day after the publication of "Moneyball" author Michael Lewis’ latest book “Flash Boys: A Wall Street Revolt” which concludes that the market is rigged by HFT traders. Incidentally, Michael Lewis has the ability to take a complex topic and explain it very clearly in layman’s terms, and his book “The Big Short” is one of the best (in my opinion) at explaining clearly the events leading up to the financial crash of 2007-10.

As Wikipedia describes HFT, it is:

…a type of algorithmic trading, specifically the use of sophisticated technological tools and computer algorithms to rapidly trade securities. HFT uses proprietary trading strategies carried out by computers to move in and out of positions in seconds or fractions of a second. Firms such as British-based Algorates, one of the first to employ HFT, rely on advanced computer systems and the processing speed of their trades to record high earnings in the market.

High-frequency traders move in and out of short-term positions aiming to capture sometimes just a fraction of a cent in profit on every trade. HFT firms do not employ significant leverage, accumulate positions or hold their portfolios overnight. As a result, HFT has a potential Sharpe ratio (a measure of risk and reward) thousands of times higher than traditional buy-and-hold strategies. HFT firms make up for low margins with a high frequency of trades.

If you have the money to invest in setting up your operation, it appears to be rather lucrative. JP Morgan Chase & Co. did not lose money on any single day in 2013 (when intra-day trading is included, and why they conceal these numbers is another issue), but if you think that is impressive, another HFT firm, apparently a ‘titan’ called Virtu, had just one day in four years of trading when they lost money.

As the always excellent web site zerohedge.com concludes:

It also explains why fundamentals haven't mattered in years - the only thing that does matter is to quickly open one's own HFT stop, front-run as much order flow as possible, and scalp pennies ahead of the bid and ask... billions and billions of times, leading to the statistically improbable chart pictured above.

This, ladies and gentlemen, is why retail has given up - when companies want to go public and no longer even hide the "secret sauce" which confirms beyond a reasonable doubt that there is a two-tier market: one in which the HFTs just never lose, and one for everyone else, well: who would want to play in a casino so explicitly rigged?

Now some readers will know already where I am going with this, but it is hard not to see parallels with the Court-Sider Trading (CST) activities which came to widespread attention at the Australian Open earlier this year.

The type of trading is similar, relying of speed rather than ‘fundamentals’, and as the currently unregulated practice becomes more widespread and well-known, the public will similarly no longer want to play in a casino, where the ‘rules’ are so lax that Court-Sider Traders seldom lose.

Perhaps I should write a book on the topic, and hope that the UK’s Gambling equivalent of the FBI will take a look at the practice the day after publication? But then I am not Michael Lewis. And the Gambling Commission is not the FBI.