High frequency trading (HFT) is finally getting some of the mainstream attention that it deserves, with an FBI fraud investigation, a critical segment on 60 Minutes, and now a Wall Street Journal op-ed from founding and managing principal Clifford Asness defending HFT for supposedly reducing the cost of trading.
High frequency trading defenders says it improves price discovery
High frequency trading, as a broad set of strategies that all depend on being faster than competing traders, is opaque both because HFT firms don’t want to reveal the tricks of the trade and lose their edge, and because most people don’t have the technical background necessary to understand those strategies in the first place. It’s easy to explain why Twitter Inc (NYSE:TWTR)’s stock price is hard to justify, even if people disagree, but understanding momentum ignition strategies require a sophisticated understanding of market structure.
“If you find the discussion overwhelming, we have some good news: The debate can be understood without knowing how equity orders are routed, matched or canceled,” writes Asness.
His version of the argument is simply that high frequency trading is the next evolution of market makers, improving liquidity and price discovery. This is the standard argument in defense of HFT, and it’s already controversial, but this version of high frequency trading ignores the more serious abuses that HFT allows. Critics complain that front-running, layering, momentum ignition and other trades are really just high-tech forms of market manipulation that regulators have yet to catch up with. Zero Hedge in particular has been a steady HFT critic (and seems to have gotten a subtle hat tip in the WSJ article).
high frequency trading deserves more scrutiny, even if it is legitimate
Asness sees this as the old guard just trying to hang on to their fading advantage. “High-frequency traders tend to [make markets] best because their computers are much cheaper than expensive Wall Street traders, and competition forces them to pass most of the savings on to us investors. That also explains why many old-school Wall Street traders hate them,” he writes, possibly referencing a recent Wall Street Journal op-ed from Goldman Sachs Group Inc (NYSE:GS) COO Gary Cohn attacking high frequency trading. Asness has in turn been criticized for simply defending his own trading style, but he says that AQR is a quant fund that doesn’t use high frequency trading.
It’s entirely possible that both sides are true: high frequency trading might have brought down the average cost of trading over the last decade while also manipulating prices and covering up insider trading in specific instances. The fact that the practice is getting so much attention will hopefully spur regulators to separate the good from the bad instead of relying on the opinions of traders wither vested interests.