Larry Tabb from the TABB Group says that markets should get more expensive, not less expensive, if they want to be stable.

Larry Tabb

In an interview with ValueWalk, Tabb, the founder of research firm TABB Group and a man who sits on sits on a regulatory advisory committee on high frequency trading (HFT), said the HFT debate is focused on the wrong topics as he notes that important “shock absorbers” have been eliminated from markets.

“Investors are coming to the market armed with a knife and the other guy has an Uzi sub machine gun”

“Investors are coming to the market armed with a knife and the other guy has an Uzi sub machine gun,” he said. “Then they wonder why they walk out dead – or they don’t walk out.”

Speaking directly to institutional investors who have been at the center of complaints regarding HFT, Tabb didn’t mince words:  “You don’t come in to the market with a 20,000 share order and put it on the bid,” he said, referring to public comments from certain hedge fund executives who have complained about not being able to fully fill their orders with the displayed price quote from major exchanges.  “You break things up, spread it out, work with pools you trust. If investors don’t take time to understand how the markets work and then they walk away and say ‘my pockets got picked,’ what do they expect?”

Does “smart money” understand how markets work?: Tabb

One interesting revelation that has resulted from publication of HFT trading book Flash Boys is that institutional investors, who are assumed the “smart money,” really don’t understand how the markets work, which Tabb thinks is a problem.  “(Institutional) Investors are making significant investments, spending significant money, to determine where to deploy their assets. Are they spending enough in implementing those decisions?  Are they taking care to figure out how to implement those decisions and the leakage that comes with those decisions?”

Creating the illusion of illiquidity

Tabb notes that the SEC has designed its regulation to direct markets to focus on 100 to 500 share orders, but the regulatory agency didn’t anticipate three significant developments:

1)      We would get into this race for speed that we see now
2)      The markets would fragment as much as they did
3)      Large institutional orders would be broken into retail-sized packages and executed in micro-seconds

These changes created the illusion that markets were more liquid for institutional investors than they really were.  “If you think you can walk into a market and buy or sell 30,000 shares and not get your face ripped off you’re being naïve,” Tabb said.

When considering prescriptions for an “ideal market,” Tabb said that considering prescriptions before defining the type of market you want is irrelevant.  Does the SEC want a market for institutional investors or retail investors?  Do they want a stable market or a market where investors can get in and out cheaply?  “The low cost of entering and exiting the stock market creates incentives for short term behavior,” he said, noting that a cheap price to get into the market is a double edged sword.  “I would actually prefer more expensive markets,” he said. “I want sticky investors who are committed for the long term,” he said.

The cost of entering a market can be the difference between “trading” and “investing.”  Tabb wants a market that caters to investors.