High Frequency Trading Judgment Day

More than one trading desk has adjusted their overall focus away from day trading and towards longer held trades around the world. Why? High Frequency Trading programs are a main culprit.

I’ve chatted to a bunch of traders (employed by the big banks and/or trading on their own or through  boutique shops) and many of them feel like the game has significantly changed. Many have indicated that until recently, it wasn’t uncommon to find orders for stocks that were placed by rookie/novice traders that unknowingly showed their hands, ready to be pounced upon by seasoned vets. The problem is that, these days, the automated HFT programs sniff these opportunities out before a human can.

Programmers are developing formulas that ultimately drive the HFT programs, and these programs only care about fast execution to extract any and all profits available. When multiple HFT centres are operating in the same stocks – it’s almost a sure bet that something akin to the “flash crash” will happen again, perhaps owing to a positive feedback cycle (with negative outcomes to market integrity).

So my question is, when will that “Judgment Day” rear its head? When will “Skynet” become self-aware, forcing regulators to try to pull the plug (substantially regulate HFT)? I think we only saw a glimpse of what could happen (see this article on ETFs that momentarily lost over 90% of their value in minutes – tip of the hat to The Canadian Capitalist for the link.)

If the May 6th Flash Crash wasn’t the tipping point, what will be? Scary.

Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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Showing 7 comments
  • MarkWolfinger

    “If the May 6th Flash Crash wasn’t the tipping point, what will be? “

    When Congress develops the backbone to tell the banking/Wall St lobby to get lost.

    Don't hold your breath.

  • Michael James

    I guess I see things little differently. I don't see it as the ETFs having lost their value. I see it as some people parting with their ETF units for far less than their true value.

  • The Passive Income Earner

    I would be curious to see how many trades of BP the HFT system is actually doing.

  • Preet

    I agree with your statement. To take it a step further, and for precision, it would be people parting with their ETF units for less than the Net Asset Value – which may or may not be reflective of true value – although if they were using plain, broad-based index ETFs this is going to be pretty close to the same thing most of the time.

    At the end of the day though, the HFT programs are causing problems was the main point, I didn't really want to get into premia and discounts to NAV! :)

  • Michael James

    It's definitely possible for a collection of HFT programs to get in a positive feedback loop and drive ETF prices up or down unreasonably far (even away from NAV temporarily). From the point of view of a long-term investor, I just have to make sure I use limit orders and avoid trading on days when spreads are unusually high.

  • Preet

    I with you on that – no reason for long term ETF investors to get really worried about the ETF structure. I'm sure there will be lots of hype examining this chink in the armour, but really I don't think it will be a big, pervasive problem by any stretch of the imagination…

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