“The markets are rigged. … These firms make their money by front-running trades. They’re using their speed advantage to buy shares first and then selling them back at a higher price. The result is higher prices for investors in those shares. That’s rigged.” Michael Lewis
Based on the Federal Reserve Board’s actions of the past five years, you may have thought that “market rigging” was a good thing. After all, a great deal of wealth has been created from the Fed’s bond buying – although, granted, almost all of it went to those who were already wealthy.
But suddenly, high-frequency trading is being charged with rigging the markets and it’s creating a bit of a furor. Apparently the Fed is responsible for good rigging and HFT is responsible for bad rigging. Consider this week’s HFT-related news:
- Michael Lewis, author of Moneyball, was interviewed by “60 Minutes” in advance of publication of his book, Flash Boys, in which he makes the case that HFT rigs the markets against the small investor.
- There was the heavy backlash from those who disagree with his conclusion … that is, the people who make money off of high-frequency trading. Supporters contend that HFT has created liquidity and reduced the cost of trading for small investors. In other words, the market is rigged against small investors, but it costs them less to make a trade. Yippee!!
- Then there’s The Wall Street Journal’s announcement this week that HFT is being investigated by the FBI – not the Securities and Exchange Commission (although it is participating in the investigation), the FBI. You know, the guys who investigate bank robberies, money laundering, drug cartels and the Mafia. And now you can add high-frequency trading to that list. Apparently, insider trading was already taken.
- Charles Schwab this week called HFT a “growing cancer that needs to be addressed.” The letter from founder and Chairman Charles Schwab and President and CEO Walt Bettinger says, “High-frequency traders are gaming the system, reaping billions in the process and undermining investor confidence in the fairness of the markets.” Since when does fairness matter?
- And finally, Bloomberg reported that high-frequency traders are moving aggressively into the trading of currency. So we will soon find out how market-rigging central bankers adapt to market-rigging high-frequency traders.
Drugs, Bank Robberies and HFT
Lewis, of course, isn’t the first to criticize HFT. We’ve done so ourselves with high frequency, including our posts, “The Truth About High-Frequency Trading” and “Where’s the Equity in High-Frequency Trading?”
But if high-frequency trading is so good for investors, why is the FBI investigating it?
According to The Wall Street Journal, the FBI investigation has been ongoing for the past year. Among other things, the FBI is investigating whether “high-speed firms are trading ahead of other investors based on information that other market participants can’t see,” aka front-running.
Well, duh! The only thing shocking is that it’s taken the FBI a year and the investigation is still ongoing. Other practices that are being investigated have become part of the HFT lexicon, including, courtesy of Zerohedge:
- Subpennying. Providing a “better” bid or offer in a fraction of a penny to force the underlying order to move up or down.
- Quote stuffing. The trader sends a huge number of orders and cancels them, which is a lot like the guy who orders a dozen pizzas and never shows up to pick them up.
- Layering. Multiple, large orders are placed passively with the goal of “pushing” the book away.
- Order book fade. Lightning-fast reactions to news and order book pressure lead to disappearing liquidity.
- Momentum ignition. An HFT trader detects a large order targeting a percentage of volume, and front-runs it.
We doubt that such practices make markets more efficient, but if they do, we’d be better off with inefficient markets.
It’s All About the Money
If high-frequency trading exists to make its users money – and of course it does – it’s only logical that high-frequency traders would make the world’s currency their next target.
Making money from money. What could be more logical?
Zerohedge notes that HFT is filling the void left by the release of a growing number of “carbon-based” traders who were guilty of “pervasive and ubiquitous manipulation of currencies.” But HFT can do more than fill the void. No human can hope to trade with the speed and efficiency of a computer armed with the right algorithm.
“As brokers get better at cloaking orders and volume shrinks in stocks,” Bloomberg reports, “speed trading remains a growth business in the $5.3 trillion foreign-exchange market, where authorities on three continents are examining the manipulation of benchmarks.”
With central banks worldwide manipulating currency and high-frequency traders manipulating currency, does anyone really think the markets aren’t rigged?