Monday, June 07, 2010

Scott Paterson sounds the alarm on high frequency trading

He reports:
The ability to estimate price moves ahead of the national best bid and offer price, which is consolidated electronically from exchanges, can give traders an advantage of about 100 to 200 milliseconds over investors who use standard market tools, according to a November 2009 report on such trading activities by Jefferies & Co.

An advanced look at exchange data and order flow can provide firms "the ability to forecast future prices" and "make adjustments to their orders in the market or send new orders which are based on this information," the report found.

Some investors are searching for ways to protect themselves. Rich Gates, co-founder of TFS Capital LLC, started becoming concerned about latency arbitrage in early 2009 after a Wall Street bank pitched the trade to his firm.

In hundreds of tests, TFS has found that some of its trades were getting picked off by firms exploiting the time-delay wrinkle. That was costing the firm money.

I agree that the markets are not perfectly efficient. Those with material information first mover advantages will take profit out of the market. Those of you who subscribe to Darwin's natural selection will recognize a similar inequality between a tall, handsome, intelligent, athletic, musical and funny chap getting more dates than his short/dull/clumsy/unskilled/boring counterpart. Even if the latter's genes might be stronger in the autoimmune and nurturing departments.

Market efficiencies are a heck of a lot better than half a generation ago, when instead of 2 cents, it was more than 10 times that amount.

Let's not make perfect the enemy of the much-improved.


  1. Anonymous3:15 PM

    Uhh...why not just fix the latency of the NBBO so that high frequency traders don't front run it? Seems easy.

  2. It might be as easy as fixing the waiting times at the Hudson River crossings between NJ and NYC.

  3. Anonymous10:59 AM

    Read "Broken Markets" by Themis. To make it so orders aren't front run, you just need to decrease latency of SIP feed and increase latency of direct market feeds. Or better yet, just investigate relationships between HFT and exchanges. Tradebot and Getco both own BATS.