Flash Crash Trash Traders - going the the way of the Dinosaurs?

The flash crash back on May 6th was a wake up call to average investors that both the stockmarket isn't a money tree in the back yard and that, to a certain extent, the market was now rigged in favour of the so-called High Frequenct Traders (HFT) who use computing power to scalp their way through the market each day and take miniscule points almost at the speed of light which add up to decent amounts at the end of each day. These traders are no different to the scalpers outside your favourite sporting fixture or concert and as such add nothing to its efficiency or effectiveness of helping the stock market it do its job.

On the other hand some say HFT provide liquidity. We'd say they distort the market in the best modern example of Gresham's law in modern finance. That is, bad money drives out good. Now obviously the HFT believe they have a role to play but Andrew Haldane (yes again) summed them up really well recently in his speech "Patience in Finance) saying:

On 6 May 2010, the price of more than 200 securities fell by over 50% between 2.00pm and 2.45pm.32 At 2.47pm, Accenture shares traded for around 7 seconds at a price of 1 cent, a loss of market value close to 100%. No significant economic or political news was releasedduring this period.

"While HFTs are not new, their speed of execution has undergone a quantum leap. A decade ago, the execution interval for HFTs was seconds. Advances in technology mean today’s HFTs operate in milli- or microseconds. Tomorrow’s may operate in nano-seconds.

HFTs operate in size as well at speed. HFT firms are believed to account for more than 70% of all trading volume in US equities, 40% of volumes in US futures and 20% of volumes in US options. In Europe, HFTs account for around 30–40% of volumes in equities and futures. These fractions have risen from single figures as recently as a few years ago. And they look set to continue to rise.

Asian is not immune from these trends. HFT is believed to account for between 5 and 10% of Asian equity volumes. In China, HFT is still in its infancy. But market contacts suggest as much as 80–90% of trading on the Shanghai stock exchange may be done by day-traders, many small retail investors. Impatience is socially, as well as technologically, contagious.

This evolution of trading appears already to have had an effect on financial market dynamics.

The causes and consequences of this “flash crash” are no clearer now than at the time. But it is known that a number of large HFT trading positions coincided with these chaotic dynamics. In response, market-makers and liquidity-providers withdrew. Gresham’s Law re-emerged as bad money drove out good, its effects now taking milli-seconds rather than months. Trading in securities generated trading insecurities. The impatient world was found, under stress, to be an uncertain and fragile one."

Writing in "Zero Hedge" blogger "Tyler Durden" refers to an article from the FT about the slowdown in trading which this month seems headed for a new three year low.

Source: Bloomberg, Spotlight. Idea: FT and Zero Hedge

We'd been careful of calling the article "placed" but it seems to us it is slanted toward supporting brokers who have been transacting for HFT and who are lamenting the lowering in volume from the HFT sector. Specifically the article says;

"Diego Perfumo, an analyst at Equity Research Desk, said that efforts by global regulators following the May “flash crash” were reducing volumes by high-speed firms, which was making it more difficult for other investors to trade.

“Higher trading scrutiny combined with tighter regulation is drying up the liquidity provided by high- frequency traders. Lower liquidity is symbiotically affecting volumes from traditional investors,” he said."

We'd argue that the correlation runs the other way. Having seen the flash crash "real" investiors and speculators now know they can't just trade on fundamentals or even technicals intra day but rather the market will move with volume that no system available to them can predict. Thus they are not playing and providing the trade flow for HFT to scalp.

We hope that market volume slows enough to put these HFT out of business. If legislators won't do it then perhaps the market can regulate itself afterall. Perhaps time has really speed up such that flash crash trash HFT will have the shortest half life of any financial innovation and go the way of the dinosaur.

FT Article that kicked this off
 http://www.ft.com/cms/s/0/81de5a8e-c731-11df-aeb1-00144feab49a.html

Zero Hedge article that prompted this Blog
 http://www.zerohedge.com/article/further-confirmation-irrelevance-stock-markets?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+zerohedge%2Ffeed+%28zero+hedge+-+on+a+long+enough+timeline%2C+the+survival+rate+for+everyone+drops+to+zero%29

Andrew Haldanes Speech http://www.bis.org/review/r100909e.pdf