Algorithms, Arbitrage and Broken Things

It's all the algorithm's fault. That's the essential unifying argument of the anti-high-frequency trading (HFT) lobby, which is happy to blame everything from the Flash Crash through to the Hash Crash on arbitrage strategies and fast turnover of trades. Tighter spreads and better liquidity! That's the answering, wall-punching, macho pabulum from the pro-HFT lobby, which is happy to ignore the negative effects of high-frequency models in favor of the idea that more is better.

Neither are entirely correct, of course. I've been thinking a lot about balance over the past few weeks, and how the truth in diametrically opposed ideologies, more often than not, lies somewhere in the middle. Take Margaret Thatcher's legacy in the UK, gun control in the US, or any other debate where either side is so charged against the other that it can't see the wood for the trees, or in this case, the cause for the effect.

First-Past-the-Post
The idea of liquidity provision and technological advantage has been reopened in recent weeks via the world of foreign exchange (FX), with the release of EBS's HFT-mitigating platform, and that of Tradition's ParFX. None are quite willing to come out and say they're there as a direct response to HFT ("Most of our customers are high-frequency traders," said Tradition, when I asked them if the platform was aiming to mitigate the effects of HFT), but it's essentially the reason. If you're not quick enough, you're not at the front of the line, and people don't like that. Fair enough.

But there are arguments on both sides of the divide that need sober analysis. Pro-HFT corners like to point to the enhanced liquidity that HFT provides, but is that necessarily good liquidity? Is the state of the market solid enough to be taken advantage of? On the flip side, does HFT really exclude the retail investor from the equation in any real sense, and put bluntly, does Joe "I trade maybe once per month" Average Investor really care about securing pennies in his stock price before an algorithm jumps in and grabs the differential? Sure, the day traders or professional private traders might get aggravated, but I'm not sure the average citizen investor that anti-HFTs are so keen to protect really gives much of a toss.

Dropping Out
Likewise, let's talk about crashes. The Flash Crash terrified everyone into believing that HFT was an aggressive predator, waiting to tear the throat out of the market at the first opportunity. Because that probably helps the bottom line. But it wasn't really HFT that caused the Flash Crash, or the other mini-crashes, or the so-called Hash Crash (I've learned to loathe that name already, and it's not even lunchtime on Monday). That doesn't get HFT off the hook, as it certainly made the problem much worse than it otherwise would have been, by emphasizing the plunge. The almost total lack of motivation to engage in the public debate by some of the larger HFT bodies, and the hesitance with which market participants approach even the prospect of discussing it with the press, doesn't help either.

The Flash Crash terrified everyone into believing that HFT was an aggressive predator, waiting to tear the throat out of the market at the first opportunity. Because that probably helps the bottom line.

But the whole point here is that you need to mix a little reality with the fiction. HFT isn't going to go away, unless it's legislated into the ground, and even then it'll re-emerge in a new Boogeyman form that will send people screaming to Twitter. While it's around too, incidentally, many on the sell side probably have an obligation to engage in it. And it isn't responsible for every major market event either. You can Occam it up as much as you like, but that doesn't make it true.

However, it does need a level of oversight, and as much as the pro-HFT lobby claims to want more informed debates, shrilly sticking to "tighter spreads and better liquidity" isn't necessarily practicing what it preaches. Warts and all, the only way to talk like adults about it is through balance.