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Is high frequency trading creation of evil genius? [updated April 20, 2014]

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HFT“There has been in our culture, in the past decade in particular, a group of reasonably smart people who hired incredibly smart people – mathematicians mostly – to design algorithms that exploit time/space phenomena such as latency to vacuum insane amounts of money out of the economy, for doing absolutely nothing except exploit systemic flaws in the digitised financial world. We’re talking about hundreds of billions of dollars, if not trillions, simply for hiring bright grad students, hurling some cash and some lap dances at them, then hitting the return key and making a billion dollars in a wink of an eye.”

Full article, as published in FT, is here.

Some more accounts on nature of HFT are here and in more detailed way here (particularly, the part from 7:55 to 9:00 about qoute stuffing and the rationale behind qoute stuffing: it is easier to make noise than to make meaning from the noise).

No doubt, the reports in both literary and technical versions have a substantial degree of accuracy. There are investment pools out there. Often closed to outside investors and often generating astronomic returns and, yes, involving bright quants; and different groups often dominating different exchanges/markets/countries.

Is this all evil? Of course, not. First of all, there are markets where this does not work, forex as an example. Then, no need to revisit the shortbacks of open outcry — the total transaction costs, and slippage cost as a separate item, were much higher. The exchange systems improve and, as time passes, HF groups will bring each other beyond the point of profitability.

What will remain is efficient, safe technology allowing for low transaction costs. Anyway, none is going to cut 2/3rds of trading volume, i.e. the share of volume HFT accounts for in many markets.

 

Update on April 20, 2014:

I´ve been blissfully uninformed when I wrote the initial post. Looks like there is a bit of evil in HFT. But just a bit. If it is true that the whole stock exchange system was redesigned by HFT operators to gain priviliged access to market data enabling them to skim majority of market participants (i.e. 99.9+% of them) in a systematic way, I would not say it is all good. However, transaction costs are tens of times lower than they were before trading moved from open outcry pits to servers. In that context, the investors are still better of and the fact that HTFs are skimming us is a minor side effect.

Nevertherless, even this side effect may be a thing of past as it has attracted some attention and is likely to cease. Let’s see if they dig up something in this process. And there is a good literary account how HFT process works:

[watching the same symbol in private account and on Bloomberg terminal]  ¨In his private brokerage account he set out to buy an exchange-traded fund … ¨I hadn´t even hit Execute¨ …  ¨I hadn´t done anything but put in a ticker symbol and a quantity to buy. And the market popped.¨ (Page 67, Flash Boys by Michael Lewis)

 

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Written by A.S.

October 27, 2013 at 11:07 am

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