On “60 Minutes” last night, author Michael Lewis made a bland assertion: High-frequency traders, he said, working with U.S. stock exchanges and big banks, have rigged the markets in their own favor. The only surprising thing about Lewis’s assertion was that anyone could be even remotely surprised by it.

The math on trading is simple: It is a zero-sum game. One trader’s gain is another trader’s loss. Only in the case of HFT, the losers are the investors — by way of their pension funds, retirement accounts and institutional funds. The HFT’s take — the “skim” — comes out of these large institution’s trade executions.

Trading on Speed

The technology behind HFT may be complex, but the math is that simple. Once the Securities and Exchange Commission allowed stock exchanges to share with traders all of the unexecuted incoming orders, it was hard not to make money by skimming a few cents or fractions of a cent from each trade. Several years ago, the founder of Tradebot, one of the biggest high-frequency firms, had said that the firm had “not had a losing day of trading in four years.” The firm’s average holding period for stocks is 11 seconds.

Any professional trader can tell you that his job is to manage risks. It is a statistical certainty that a percentage of trades will be losers. You are establishing a position with an unknown outcome. Sometimes they go your way, other times they go against you.

How is it possible that one of the largest high-frequency trading firms executes millions and millions of orders for four years without ever having a down day? The short answer is what they do is not trading — it is skimming. I call it legalized theft. High-frequency trading is a tax on investors, encouraged by the exchanges, allowed by the SEC. It is prima facie proof that something is amiss.

Regardless, to those of us who recognize HFT as a problem, Lewis’s comments are good news. He is out promoting his new book, “Flash Boys: A Wall Street Revolt.” As America’s pre-eminent chronicler of all things financial, his comments will reach a wide audience among the public and among politicos in Washington.

This isn’t the first book on the subject. If you want to dive into HFT, I would suggest reading “Dark Pools: The Rise of the Machine Traders and the Rigging of the U.S. Stock Market,” by Scott Patterson. For a practitioner’s perspective, see “Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street are Destroying Investor Confidence and Your Portfolio,” by Sal L. Arnuk and Joseph C. Saluzzi.

It is interesting to note that the rigging theme is consistent with everyone who looks closely at this subject. My colleague Josh Brown notes that markets haven’t become rigged, they have always been rigged. What is different is the ability of high-frequency traders to see other people’s orders, jump ahead of them, and then sell that exact same stock to them, at a higher price. It is the ultimate market-skimming operation.

The specialist system that pre-dated HFT had its flaws, as we saw in the 1987 stock-market crash. But it also had one crucial redeeming factor: A human being stood ready, willing and able to make a market in a stock when other buyers and sellers disappeared. HFTs, on the other hand, have no such obligation. When things get rough, they unplug their machines. This makes their claims of added liquidity laughable. They are the centerpiece of a flawed system without any socially redeeming qualities.

I am looking forward to reading “Flash Boys.” I hope our members of Congress and the folks at the SEC do so too.


Originally published here

Category: Regulation, Technology, Trading

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

25 Responses to “Rigged? High Frequency Trading Is Legalized Theft”

  1. DeDude says:

    “Once the Securities and Exchange Commission allowed stock exchanges to share with traders all of the unexecuted incoming orders”

    Right there is the scam, corruption and insider trading. The exchanges are bribed to give insider information that allows the criminals to front run regular investors. There is a reason that you should never allow exchanges to be privately owned and run as for profit.

    However, none of this would be profitable if we had a sufficiently high tax on every bid, offer and trade. Low frequency of trade serve the economy, high frequency of trade serve the vultures – so get rid of it with a good fat tax.

  2. Global Eyes says:

    HFTs might hold their stocks for an average of 11 seconds but they steal profits for a lot longer. Leverage is their drug of choice-ask any high frequency trader.

  3. VennData says:

    So why hasn’t a flash crash happened again?

  4. A says:

    Interesting how one primary, honest guy (an exception, I know) was able to bring this to light.

  5. arthurcutten says:

    Stephanie Ruhle had an interesting discussion of this subject on Bloomberg TV this morning with NY AG Eric Schneiderman, with Eric Schatzker throwing in an occasional deviation from the script in the interests of reality. Schneiderman was being politic, with Ruhle in her familiar role as cheerleader for the plutocracy.

    It was very discouraging. Reform will not come until something breaks, badly.

  6. gfreedy says:

    “The only surprising thing about Lewis’s assertion was that anyone could be even remotely surprised by it.”

    The part that was news to me was how it worked which was explained rather simply and succinctly. I’m sure as Barry points out it’s old news for anyone in the business but understanding the details is what has been missing for the average Joe. I just hope the 60 Minutes exposure is the straw that breaks the camel’s back regarding fixing the HFT racket.

  7. arthurcutten says:

    In fairness to Schneiderman, what was specifically disappointing is that he trotted out the old saw that HFT itself is good because it ‘provides liquidity’ and portrayed just the specific front running aspect of it as questionable.

    • DeDude says:

      Yeah you kind of wonder why nobody can come up with an argument for why trades in 1 second intervals is not providing exactly as good “liquidity” as faster trading. HFT does nothing but harm to the markets, and when liquidity is actually needed HFT pulls it away instead. So lots of liquidity when it is not needed and none when it is – what a gift, but to whom?

  8. td says:

    If Im logged on to my ETrade account buying to hold long term and using a limit order then……so what? The hook on the outrage here is that the slicksters are jumping in front of Ma and Pa retail investor and screwing them out of their honest wages….but what also happens much more often is that speculators who are trying to make a quick buck off volatility get beat out by someone who is able to make an even quicker buck. If hedge fun ABC gets in front of hedge fund XYZ’s trade then Im not inclined to shed too many tears over it one way or another. That said if HFT went away tomorrow I’d be fine with it but it wouldn’t suddenly usher in a new era of egalitarianism for retail traders.

    • Bob says:

      If you are buying 500 or 1000 shares, you can use a limit — but what of your pension or IRA or 401k ? The institutions making those buys do so in much bigger quantity — they cannot use a limit order 3 cent above the market

      No is scalping your orders, its your retirement account orders that are getting skimmed

    • Iamthe50percent says:

      Consider use of a stop loss. Knowing ALL the market orders, it is easy to do a phony sale of a hundred shares from one dark pool to another, triggering the stop and scooping up your shares cheap. I say phony sale but it is legal because two accounts are used. I can’t prove anything but twice I’ve had stops ten percent below the market and WHAM, the price blips down, triggers the stop, someone picked it up and the next trade was more than ten percent higher. I’ve quit using the stops. Your stop loss order just tells someone how low you are willing to sell at. NO ONE should know about your stops and limits but your broker.

      You may say, “Who would bother scooping up some little muppet?” But the computer can rob ten thousand muppets a second. That adds up to real money.

  9. MarkKlose says:

    Barry you’re absolutely right about this being nothing new and hopefully with a widely read author like Lewis and 60 Minutes behind the current effort to educate the public, it will get more exposure. Last September, Norway’s Sovereign Wealth Fund (Norges Bank Investment Management) made this very charge.


  10. NMR says:

    It certainly didn’t come as any surprise to me. I’ve believed for years that HFT was facilitating front running and other manipulations but what are you going to do? I suspect this book is going to make big waves. The public already knows for a fact that the mortgage, Libor and Forex markets were rigged now they’re hearing an easily understandable form how it’s done in equity markets. I bet the big boys are meeting with the flaks and lawyers this morning…LOL

  11. maspablo says:

    This in my mind is the issue. $$$$
    Im not sure what Big Picture conference it was , at least 2/3 years ago . Barry had Sal Arnuk and Joe Saluzzi , they let this little tidbit out , the NYSE makes more $$ from server storage than trading., and I am sure its the same for the other exchanges . No exchange has incentive to stop HFT if it makes its money from HFT , which pay $ to have there servers located next to the exchanges servers .

  12. rd says:

    Just one of many areas of legalized theft in the financial sector. Other than some well-publicized, relatively small insider trading prosecutions how many prosecutions of financial crimes have occurred since 2007? The two excuses usually trotted out by DoJ and others is that it is really “difficult to prove” or that it wasn’t against the law.

    It seems pretty clear that most tradeable things (Libor, commodities, CDOs etc.) have been rigged by the large financial firms. Post Enron and SarbOx, stock trading is probably one of the most transparent things. Even the Fed is in on the act, with blatant interference in the bond markets and bankrolling speculation in the TBTFs).

  13. ckaussner says:

    High frequency trading? More like high frequency theft. But no laws were broken and “one lawyer with a briefcase can steal more than a hundred guys with guns”. Nothing to see here – move along.

  14. Lyle says:

    With computers you could solve the problem of large blocks (which it appears was the first way Goldman grew big). Tell the computer to sell 1000 shares every 20 mins or so. Avoiding the big block trades by this method might work, you could move 18,000 a day this way. If a larger block just don’t be so impatient, spread it out. The idea would be to look at the daily trading volume in the stock in question and avoid doing more than 1% of it in a day. Use the computer to fight back against the computer!

  15. lucas says:

    “The firm’s average holding period for stocks is 11 seconds.” I do not understand this part. My discount broker says if a customer buys and then sells before at least three days pass (settlement period), the customer will get a warning note about breaking SEC rules. Get three notes, and the broker will place a limitation on your account. I nearly fell into this during the volatility of 2008 when I would place trailing stops only to have them mysteriously filled even as the price of the stock in question was rising. The broker insisted that the price had gapped down. In fact, even a trailing stop of as much as 30% would trigger, and I learned that any trailing stop can be “front-runned” so to speak, allowing the market maker/specialist to grab your shares at a big discount and instantly resell at the market price.

    So how does a firm whose average holding period is 11 seconds avoid running afoul of the same SEC rule?

    PS, Barry, how can your readers ever know if their question was answered? There are no email alerts or anything.

  16. howardoark says:

    I have no idea myself, but it’s possible that the HFTs do provide more value than they’re skimming off by increasing liquidity. Their cut, while probably hundreds of millions, may not be a significant amount of money compared to the overall market.

    • NMR says:

      The liquidity alibi is largely baloney. They make millions of buy orders but they cancel millions also. HFT represents about 60% if volume so I’m sure it’s more than a few hundred million in profits.

  17. constantnormal says:

    Market makers and creatures of that ilk play by a different set of SEC-imposed rules than thee or me. They do not run afoul of our SEC rule book because they play by a different SEC rule book.

    When you own the people who write the rules, you can have your own customized rule book that favors you above all others.

  18. realitician says:

    Yes, the liquidity argument is baloney. That has been provided by market makers and exchange specialists for a long time. The sharing of unexecuted trade information should never have been made legal. It presumably includes all stop and limit orders as well — which leaves investors wide open to being picked off by the algo traders. I suspected that was happening to me years ago, and so, regrettably, I stopped using them. Better to get skimmed a little on a market order than completely ripped off on the entire trade. I will be checking to see if my broker uses IEX. I hope it is.