William Blair on good vs bad algorithms
When considering if there are “good” and “bad” algorithms, Brian Ziv, Partner head of hedge fund strategies at the staid investment banker William Blair, said there were points of positive and negative differentiation.
Arbitrage strategies that don’t involve front-running of information can be valuable. “Covariance matrix trading, where a move in one stock isn’t reflected in other stocks, is a legitimate and beneficial strategy,” Ziv said. “Market arbitrage can be good for markets.”
“Bad” HFT strategies center around HFT firms piling into markets at a higher ratio than markets can handle to push markets in a beneficial direction is an example of “bad” HFT, Ziv said. “It’s like a bucket shop except it is done with high speed computers.”
Bruce Mumford points the issue of significant order volumes
Bruce Mumford of Emerging Edge Group works with algorithmic traders in Chicago. He noted a key issue was the generation of significant orders and quotes that were immediately canceled, generating a storm of activity that could be construed as manipulating the computer-based electronic market making systems. Mumford says regulators have punished some firms in the past for this behavior, noting that in years previous the CFTC find Panther Trading for placing and then canceling massive amounts of orders.
Regardless of the behavior, the importance of HFT to markets cannot be dismissed. Mumford noted a Tabb Group study that said HFT represents 61% of orders on futures exchanges and nearly 50% of stock markets. “CME Group Inc (NASDAQ:CME) used to publish the breakdown of HFT, but we haven’t seen that in years,” he said.
Transparency in dark pools is a major issue for Mumford and the ability to manipulate orders, which he said trumps most HFT issues. For his part, Ziv said dark pools can be abusive, but they are used by the most sophisticated traders in the world so such charges should be taken with a grain of salt.
How to manage the HFT threat?
What should be done to better manage the HFT threat? Arbitrage that is induced by exchanges (and their rebates or payments) should be questioned, Ziv indicated. “Payment for order flow might not be illegal, but it should be eliminated,” Mumford said.
Mumford noted that Italy and Germany have imposed transaction tax, and in particular levy fees for excessive use of the system, while Ziv noted that such an approach could lead to traders moving to markets that don’t have transaction taxes.
HFT has taken profits from market makers, with the key difference between a market maker and an HFT firm is HFT liquidity might not be in the market when it is needed most, during a flash crash. In regards to the flash crash, Ziv noted the thinking has evolved to the point where industry people believe it could have been triggered by an issue with the market maker algorithms.