Tag Archives: high frequency trading

Incidence

By James Kwak

One of the criticism’s of Michael Lewis’s book is that he gets his moral wrong. High-frequency trading doesn’t hurt the little guy, as Lewis claims; instead, it hurts the big guy. The explanation is this: people sitting at their desks buying 100 shares of Apple are getting the current ask, so mainly they care about volume and tight bid-ask spreads. Institutional investors, buy contrast, want to buy and sell huge blocks of shares, and they don’t want the price to move in the process; they are the ones being front-run by the HFTs. Felix Salmon pointed this out, and it’s the subject of an op-ed by Philip Delves Broughton today.

What this leaves out is the question of who ends up being harmed. To figure that out, you have to ask whose money we’re talking about when we say “institutional investor.” If it’s SAC Capital, meaning Steven Cohen’s money, then who cares? But most ordinary people invest—if they are lucky enough to have money to invest—through mutual funds (401(k) plans, for example, are largely invested in mutual funds), and those funds are among the “institutional investors” losing money to HFTs. Another big chunk of institutional money belongs to pension funds. In this case, if the pension fund does poorly, the money may come out of its corporate sponsor in the form of increased contributions—or it may come out of beneficiaries and taxpayers in the form of a bankrupt plan shifting its obligations to the PBGC. Then there are insurance companies: in that case, losses from trading affect shareholders, but if they are systemic across the industry they end up as higher premiums for consumers.

This is not to say that the institutional investors are warm and cuddly and are just passive victims in all of this. I’ve spilled enough ink inveighing against active asset managers, and Salmon points out that the buy side bears its share of blame for being careless with other people’s money. At the end of the day, if HFT harms other people in the markets, it’s just a fraternal spat among capital, and doesn’t affect the fundamental divide in the post-Piketty world. Until a poorly-tested algorithm goes berserk and freezes the financial system, that is.

High-Frequency Trading and High Returns

This guest post is contributed by Ricardo Fernholz, a professor of economics at Claremont McKenna College. Some of his other work was profiled on this blog here

The rise of high-frequency trading (HFT) in the U.S. and around the world has been rapid and well-documented in the media. According to a report by the Bank of England, by 2010 HFT accounted for 70% of all trading volume in US equities and 30-40% of all trading volume in European equities. This rapid rise in volume has been accompanied by extraordinary performance among some prominent hedge funds that use these trading techniques. A 2010 report from Barron’s, for example, estimates that Renaissance Technology’s Medallion hedge fund – a quantitative HFT fund – achieved a 62.8% annual compound return in the three years prior to the report.

Despite the growing presence of HFT, little is known about how such trading strategies work and why some appear to consistently achieve high returns. The purpose of this post is to shed some light on these questions and discuss some of the possible implications of the rapid spread of HFT. Although much attention has been given to the potentially destabilizing effects of HFT, the focus here instead is on the basic theory behind such strategies and their implications for the efficiency of markets. How are some HFT funds such as Medallion apparently able to consistently achieve high returns? It is natural to suspect that such excellent performance is perhaps an anomaly or simply the result of taking significant risks that are somehow hidden or obscured. Indeed, this is surely the case sometimes. However, it turns out that there are good reasons to believe that many HFT strategies are in fact able to consistently earn these high returns without being exposed to major risks.

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Is The SEC Still Working For Wall Street?

By Simon Johnson

The Securities and Exchange Commission (SEC) under Mary Shapiro is trying to escape a difficult legacy – over the past two decades, the once proud agency was effectively captured by the very Wall Street firms it was supposed to regulate.

The SEC’s case against Goldman Sachs may mark a return to a more effective role; certainly bringing a case against Goldman took some guts.  But it is entirely possible that the Goldman matter is a one off that lacks broader implications.  And in this context the SEC’s handling of concerns about “high frequency trading” (HFT) – following the May 6 “flash crash”, when the stock market essentially shut down or rebooted for 20 minutes – is most disconcerting.  (See yesterday’s speech by Senator Ted Kaufman on this exact issue; short summary.) Continue reading