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High Frequency Trading: Point-Counterpoint

Posted by Larry Doyle on July 17th, 2009 6:12 PM |

High frequency trading activity has become a very hot topic both on and off Wall Street. My trading instincts tell me that this activity is not productive for the long term health and well being of the market. I have referenced the work of Joe Saluzzi and his colleagues at Themis Trading in making the case for the prosecution.

In an attempt to present a case for the defense, I searched and found commentary written by Sang Lee, managing partner at Aite Group. Lee recently wrote for Advanced Trading, In Defense of the High Frequency Trading Community:

Various potential regulations, including the reinstatement of the uptick rule and transaction tax directly threaten the business model of the high frequency trading community.

Sense on Cents counterpoint: The uptick rule required short sellers of stock to only transact at a price higher than the previous trade. Our friendly Investing Primer, Investopedia, informs us:

This rule was introduced in the Securities Exchange Act of 1934 as Rule 10a-1 and was implemented in 1938. The uptick rule prevents short sellers from adding to the downward momentum when the price of an asset is already experiencing sharp declines.

The rule worked fabulously for almost 70 years before being discontinued in July 2007. It was discontinued in an attempt to promote trading volume on the exchanges and in turn increased fees.

Sang Lee writes further in making his point:

In recent years, growth of alternative electronic trading venues has been driven by a multitude of factors: the introduction of decimalization; the adoption of FIX as the main protocol for electronic communication; the availability of technology for developing market infrastructure conducive for electronic trading; the rapid adoption of electronic trading; the adoption of algorithmic trading; and the availability of co-location services.

Sense on Cents counterpoint: Fairly obvious with all of the technological advancements that we are not looking at your grandfather’s “buying 100 shares of IBM.” Modern day trading activity is both fast paced and high energy. Little wonder why it has become so much more driven by technical analysis than fundamental valuations. (more…)

Is Uncle Sam Manipulating the Equity Markets?
Part III

Posted by Larry Doyle on July 8th, 2009 6:47 AM |

Kudos to the blog Zero Hedge for highlighting the questionable nature of the technical flows in the equity market that have occurred via high frequency program trading.

Massive kudos to Joe Saluzzi of Themis Trading for going public last week on Bloomberg with this story. While Zero Hedge, Sense on Cents, and every other financial blog sit outside the fray, Joe Saluzzi is actually ‘in the arena.’ I commend him for his character and courage in shedding light on this opaque and arcane program trading business. Yesterday on his blog at Themis Trading, Saluzzi wrote a piece entitled “Manipulation?”:

We have talked extensively on our blog and in our white papers about the power of high frequency trading and program trading.  We have noted that these trading strategies can move the market quickly  during the trading day.  We have always suspected that there have been certain major players that can dominate this space.    Now comes the case of the stolen proprietary trading code from Goldman Sachs.

http://www.bloomberg.com/apps/news?pid=20601087&sid=axYw_ykTBokE

Most interesting in this Bloomberg article is the following statement by Assisitant U.S, Attorney Joseph Facciponti:

“The bank has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways,” Facciponti said

Is this an admission by Goldman Sachs that there is the possibility of manipulation in the market?  Does anyone think that this is the only program in the world that can “manipulate” markets?  With all the programmers in the world, we can only imagine how many more manipulative programs are out there.  Now here is the best part according to the assistant U.S. Attorney:

The proprietary code lets the firm do “sophisticated, high- speed and high-volume trades on various stock and commodities markets,” prosecutors said in court papers. The trades generate “many millions of dollars” each year.

Markets are a zero sum game – somebody wins and somebody loses. Where do you think these “many millions of dollars” are coming from?  They are coming from you – the average retail investor and the large institutional investor.  These programs are taking advantage of real order flow and are siphoning off small profits throughout the day that belong in the pockets of the retail investor and the traditional money manager.

So, who is out there to protect you from these “machines” and their army of programmers?  One would think the SEC has your back.  But what did they have to say about high frequency trading.  According to an article in the WSJ (http://online.wsj.com/article/BT-CO-20090618-707189.html )

The Securities and Exchange Commission believes institutional money managers are “sophisticated” enough to trade against the machines without further regulation.

“We don’t want to curtail liquidity,” said Gene Gohlke, associate director for the SEC. Gohlke said it’s up to the managers themselves to make sure other traders aren’t manipulating their models.

This story is just at the beginning stages and we here at Themis Trading intend to keep a careful watch on it.

WOW!!! This statement by Mr. Saluzzi is as powerful a condemnation of a Wall Street business practice as I have seen in a long time.

Effectively, Mr. Saluzzi is stating that the high speed program trades ‘front run’ order flow from retail and institutional investors. This practice helps explain the disconnect between the underlying economic fundamentals and the technical support of our equity markets. The SEC has given the practice of program trading its blessing.

This smells.

For those interested in this topic, please reference previous posts by Sense on Cents on this topic:

Is Uncle Sam Manipulating the Equity Markets?

Is Uncle Sam Manipulating the Equity Markets? Part II

Kudos again to Zero Hedge and especially Joe Saluzzi!!

LD






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