Seeking the Supergenius
Market Making or Card Counting? | Seeking the Supergenius: The Life of a High-Frequency Trader
Market Making or Card Counting?
March 22, 2010
Are high-frequency traders the latest iteration of market-makers, always available to buy or sell individual securities, or is the practice of turning over large portfolios of stocks many times a day, on small price discrepancies, Wall Street's version of card-counting?
That difficult question remains unanswered, but the glare of scrutiny on high-frequency trading firms is getting harsher. Sen. Ted Kaufmann (D-Del.) has called upon the Securities and Exchange Commission to investigate whether high-frequency traders manipulate markets and put other participants at an unfair disadvantage.
For their part, high-frequency traders mostly are reluctant to talk in any detail about what they do. Often but, in some cases mistakenly, called algorithmic traders, they can go under the nickname "prop shops" because their trading algorithms are their competitive advantage, held closely and considered proprietary. As such, most are media shy.
High-frequency traders argue they add enormous liquidity to the world's equity markets given that what they do presently constitutes as much as 70 percent of the daily volume in equities trading, by the estimate of the Boston-based research firm Aite Group. They also posit the vague notion that they squeeze inefficiencies out of markets.
"That is really the heart of the matter. Is high-frequency trading a net negative or positive? It's very tough to isolate one component of the marketplace and decide negative or positive," says Sang Lee, a managing partner with Aite Group, a firm which tracks the high-frequency trading industry.
The reality now is consolidation, meaning the big are getting bigger and killing off the weak, according to Lee.
"Once they suck out all the inefficiencies, it makes it tougher for [high-frequency trading] firms [to profit]. It's like they are trading with each other [when] they need a diverse transaction flow. You have a lot of mediocre guys and very few smart ones. It's not that simple, especially in the U.S equities market," Lee says. He believes the only thing that could answer the central question about impact are academic examinations, which if being done, are not widely known or publicized.
Some commercial studies have looked at the issues, but have been largely inconclusive. Traders magazine, a sister publication to Securities Industry News, in December ran an article based on wide interviewing that led reporter James Ramage to conclude "interacting with high-frequency traders can be risky." But no one knows for sure.
A Greenwich Associates survey of 87 institutional investors last fall points up the confusion and lack of understanding surrounding high-frequency trading. No consensus was reached in the study suggesting it should be regulated (see "Data Sweep,'' page 10).
"Even some of the most active institutional stock traders cannot agree about whether high-frequency trading helps or hurts institutions, retail investors or companies with publicly traded stock. Until these questions are answered, regulators should limit any new rules to narrow trading practices....," the report concluded.
One argument in favor of leaving them alone is that high-frequency traders really do not interfere with investors buying for the long term. That's the position of Ram Rao, director of sales and business development at incubator Trading Cross Connects Holdings Ltd., which bootstraps small teams of high-frequency traders.
"There really is no overlap. Someone finds good stocks and holds onto the winners. High-frequency traders try to benefit from [tiny variations] in price and by doing it in volume. They make a little bit of money per trade. They are two totally separate types of investor."
