Last week the Australian Securities and Investment Commission (ASIC) published its review of HFT (REP 452 Review of high-frequency trading and dark liquidity) as it relates to the Australian equity, bond and futures market. The review updated its prior review of 2012 which was undertaken in a period of heightened concern regarding the development of HFT.
Since the 2012 Review the famous book “Flash Boys: A Wall Street Revolt” (a non-fiction book by Michael Lewis, March 2014) argued and presented a case that HFT utilising computer trading and algorithms was being employed to unfairly skim money from equity market participants. By equity market participants, we mean the public (i.e. probably you) because that is where the skimmed profits are coming from. For every winner (or skimmer) there must be someone who pays (or loses) and that essentially means everybody who receives less when selling, or pays more for shares when buying.
It is important to understand that the overwhelming majority of HFT trades are intraday. The HFT trading entity generally does not hold positions overnight and their trading is hyperactive, across the market and very quick. So when a trade is undertaken, and particularly a short trade, it is unclear whether the HFT trader is notifying the authorities (as other market participants must do) that it is naked or covered. Importantly the party on the other side of the transaction has no idea whether he is dealing with real or phantom stock.
The proliferation of HFT activity has resulted in various dealing responses by fund managers and brokers. The ASIC review notes that computer-based trading is taking over trading activities in our market. The computers are acting for HFT, hedge funds and institutional managers. The market has become so complicated that computers are engaged to trade with and against other computers whilst humans look on.
It is this phenomenon that is creating an alarming amount of trading in the Australian equity market. To quote from the ASIC Report
 ”A significant proportion of trading in equity markets occurs for technical (e.g. price arbitrage) or speculative reasons, rather than for fundamental reasons. Our analysis indicates that, inclusive of high-frequency trading, approximately 40–45% of all market turnover in Australian equity markets is conducted on a short-term or speculative basis.”
Whilst ASIC concludes that HFT activity is not of significant concern, the report raised enough issues to suggest that HFT has many more negatives than positives. Further the Report does nothing to dampen the view that HFT skimming is occurring. Indeed, ASIC actually come up with an estimate of the value of the HFT skimming because, in their words, they are “in a unique position” to do so.
To quote ASIC: “High-frequency traders appear to have become more sophisticated. Compared to 2012, they are better at avoiding interacting with one another and they are extracting larger gross trading revenues. We estimate that they earned $110–180 million in aggregate over the 12 months to 31 March 2015. This translates to a cost of 0.7 to 1.1 basis points to other market users. This is material, but substantially less than other figures suggested by some… We are in a unique position to make this estimate because we have a complete view of all orders and trades, including participant and client identifiers.” ASIC REPORT
We agree with ASIC that this is a “material” amount of money. More importantly, it is clear if left unchecked in a growing share market then over a billion dollars could be skimmed from investors over the next 5 years. That is more than material it is outrageous.
Unfortunately, human ingenuity and the desire to greedily chase profits from every activity or endeavour is rampant in the stock market. This has meant that the stock market – which was designed hundreds of years ago to raise capital and to allow secondary trading of securities – has transformed into a place of speculation and betting. Further, it is betting that is conducted unfairly because a whole range of participants that undertake high frequency trading seem to be avoiding the same market rules that the rest of us are obliged to follow.
HFT does not enhance liquidity, and nor does it operate on valuation metrics. It is speculatively driven and if used aggressively with shorting, can create fear and panic in markets.
There are many behavioural studies that suggest that while greed and fear drive markets it is fear that is the more powerful force. Fear is a human trait that computer algorithms prey upon; and that point was totally missed in the analysis by ASIC.
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