Email of the day (1)
Comment of the Day

May 21 2010

Commentary by David Fuller

Email of the day (1)

On high-frequency trading
"As a subscriber and huge fan of Fullermoney I wanted to respond to your comments on High Frequency Trading. There is much blame falling on HFT and much of it is non-sense.

"First many different strategies are being lumped under HFT that are not part of that business. Dark Pools or flash order programs occur with high frequency trading but are separate and are rightly of concern because of fairness and transparency issues. I agree there is room for scrutiny.

"Not all high frequency trade is the same but the bulk of it is arbitrage of very small miss-pricings among highly correlated securities. Examples could be the Jun bond future with the September bond future, or the 30yr to the 10yr. members of the Dow 30 with the Dow ETF etc. Few of these strategies are directional trades. The HFT traders steps away from the market when it becomes to volatile because they have profit margins so small that a little added volatility can lead to irregularities that exceed their margin of safety. The bulk of HFT programs are not particularly sophisticated trades.

"The sophistication is in the technology and programming to achieve speed in the messaging of orders. There are exceptions but the super high volume trade is usually simple stuff with extraordinary connectivity. An example of this would be direct access to the exchange on very high speed lines. These lines are available to anyone who wishes to have them and who is willing to pay, for it costs hundreds of thousands of dollars a year. All this for profit margins in the range of 1 or 2 cents per share. These programs seek very small profits many, many times with out any big losses because of the brief exposure.

"I also hear it said they do nothing for the market or for the public. Nothing could be further from the truth. I remember when most bid ask spreads in stocks were a eighth wide, 12.5 cents and the commissions were 60 or 70 dollars. Charles Schwab was the first big discounter an he offered $39.00 minimum commissions. Those costs have collapsed and HFT has a lot to do with the lower costs. How much money do mutual funds save today compared to the past? A very large number.

"So I have no problem scrutinizing the various processes in the electronic market but let's not throw the baby out with the bath water by lumping everything under HFT and then demonizing that kind of strategy."

David Fuller's view Thank you, not least for these informed comments on high-frequency trading (HFT). In my observation HFT has been with us in various forms since the 1970s, although obviously on a much smaller scale. Yes much of it is market neutral arbitrage but with an increasing number of firms following this route, presumably chasing diminishing margins, it seems likely to me that many of the HFT firms will take on more positional trading. If so, is it just my imagination to assume that another Long-Term Capital Management-style accident will be in the making?

Meanwhile, how much of a role did HFT play in Wall Street's 10-minute meltdown on May 6th?

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