HFT a force for good or evil

It seems to me that the Industry is split between the benefits or not, of high frequency trading (HFT) and it’s a polarisation which is so concerning that Sir John Beddington, UK Government Chief Scientific Adviser, has launched his report on the Future of Computer Trading in Financial Markets.

Everyone appears to have an opinion, but very few of these are based on a sound understanding of trading – at a speed of which most average people have trouble grasping. Politicians and the man in the street treat HFT as the perfect target for the problems in the market. This view is very much based on rhetoric and envy of the huge profits that financial institutions are reported to have made and the salaries reported to be paid to traders. This negative opinion of HFT has now passed into folk law where this type of trading is referred to as ‘the Casino’.

This view is not correct and misses the benefits that HFT brings. To decide if HFT is good or bad both sides of the argument must be understood.

Whilst the supporters of HFT will normally point out the increased liquidity that algorithmic trading brings and the reduction in spreads that can be enjoyed by investors.

In reality I don’t believe that both arguments hold much water. The fact is that technology allows HFT and the structure of the markets opens the doors for this type of trading, but the investing community cannot see any evidence of tangible benefit.

We have in today’s market a two speed structure that hardly relates to each other. The vast majority of transactions traded each day are between Banks utilising HFT, to take advantage of a buying or selling opportunity in milliseconds. This activity has nothing to do with human decision making other than the flip of a switch. The algorithms that instigate HFT have no strategy and do not take into account company performance, historical analysis of share prices or any market condition other than the rise or fall in share prices. It is in fact a dichotomy as HFT activity accelerates and increases the volatility of share prices. It is therefore a self-fulfilling prophecy leaving investors at the whim of a mathematical equation. The rise and fall of share prices and market performance is therefore irrelevant. This is exactly the opposite of investing. It is pure and simple trading.

Consequently, Investment firms have been moving on mass to long term strategies, based on traditional analysis and the decision to buy or sell. The vagaries in today’s market are pretty meaningless in the long term.

The volatility in markets has rarely got much to do with economic outlook, unless it triggers a genuine sale order by long-term, large investors. Over a week the markets can swing madly up and down and end up just about where it started - hardly an attractive proposition to encourage investors, but perfect for day traders and HFT.

Society has to decide what sort of financial market it wants. There is nothing wrong with HFT, but it’s not really helpful for the increase in real investments or for new companies to list. Who wants to bring a company to market when its share price is at the beck and call of machines?

Do we want a Stock Market that attracts investors and companies to list and find capital to build new factories or develop new products? Do we want a Stock Market that contributes to economic growth but possibly is a tad more expensive?

HFT is here and it’s a successful business generating vast profits for those that can play. However, it is ‘the Casino’ and does not provide much benefit for long or shorter term investors.

As in all things in life, we need balance. With my Market Making background I have an affinity to trading, however, with technology and HFT we have a created a business that has unbalanced Stock Markets and is preventing them from fulfilling the basic investment and growth functions for which they were created.

We cannot have it both ways! HFT is either made illegal or at least artificially slowed down. Maybe a transaction tax on HFT trades would bring some consideration in to the creation of the algorithm and slow it down. Or maybe we need a new Stock Market where HFT does not form part of the market making services and where investors and SMEs are attracted to list.

So is HFT good or bad you decide?