It has become increasingly clear that the term “high frequency trading” (HFT) has been appropriated and turned into a catch-all phrase for electronic trading behavior people just don’t like. That doesn’t mean, however, that correctly using the term HFT should be avoided or that we need another phrase to accurately convey the practice; there is nothing troubling or negative about trading with a frequency greater than others.
But what is troubling is the common practice of conflating negative and even illegal trading behaviors under the term HFT. This promulgates numerous operating definitions of the term, prompting confused and often ill-informed discussions around HFT. To ensure effective discussion and helpful criticism of today’s markets, those instances must be corrected.
The recent comment letters to the CFTC concerning their “Concept Release on Risk Controls and System Safeguards for Automated Trading Environments” contained more than a few misunderstandings and misappropriations of HFT. A letter from Better Markets made a series of definitive statements about HFT that do not accurately reflect the role HFT plays in the markets. Why? Better Markets states in a footnote to their letter that they use the term HFT to refer only to manipulative and disruptive trading practices:
“While there are of course algorithmic trading strategies that are not considered manipulative or disruptive of their given markets, for the purposes of this comment letter “high frequency trading” and “HFT” refer to those disruptive high-frequency automated trading strategies as described herein.”
Better Markets also wrote:
“strategies which count as illegal manipulation when performed over the course of minutes or hours should also not be permitted when they take place within milliseconds. Moreover, practices that are clearly illegal if done by human beings should be equally illegal if done by computers.”
It is very clear that they are addressing manipulative and disruptive behavior, whether done at low latencies or by humans. One would be hard-pressed to disagree. All responsible market participants, many of which use HFT, want to do away with manipulation. However, by wrongly equating all HFT to manipulative behavior, Better Markets has muddied the water. If we are to successfully address manipulative behavior in the markets, whether executed by computers or humans, we must be clear and precise.
The inaccurate application of the term HFT to only manipulative and disruptive trading practices is not the only place we see the conflation of the term. In recent weeks there has also been a good deal of confusion between news arbitrage and HFT. The number of news releases when compared to overall market activity is small. The number of impactful, market moving releases that come out while the markets are still open is even smaller.
The very fact that these events are infrequent does not allow for them be traded with a high frequency, meaning, by definition, one would not think to apply the term “high frequency trading” to these events. Yet, institutions as esteemed as the Wall Street Journal and the New York Attorney General’s office regularly confuse HFT with an infrequent news arbitrage. AG Eric Schneiderman stated that his office is “committed to ensuring a fair, stable, and transparent market. That means cracking down on the bad actors and encouraging industry leaders to step forward and self-police their industry.” Responsible market participants were encouraged by the statement, as they too want a fair, stable and transparent market that is rid of bad actors.
However, AG Schneiderman went on to say:
“High-frequency traders who drain the value out of market-moving information in the milliseconds before it becomes available to other investors erode confidence in our markets and skim from the rest of the investing public, which hurts the entire market.”
Unfortunately this statement shows a misunderstanding of the issue at hand, alleging early access when it is unclear that was the case, and conflates HFT, a tool used throughout the industry, with an activity, news arbitrage, practiced by a small group of traders at an infrequent occurrence. Doing so creates two distractions: it distracts from the news trading issue at hand and distracts from the positive contributions HFT makes to the market.
Conflations such as these do a disservice to the investing public by ignoring the many benefits HFT brings to the market and rhetorically casting a common and legitimate trading tool in a narrow and negative light.
All responsible market participants, many of which use HFT, want to do away with the manipulative behavior taking place in today’s markets. The markets should be fair, stable, and transparent, benefitting all market participants. But until we accurately discuss the specific behaviors we need to remove from the market, rather than lumping them under the imprecise mantel of “HFT”, we will continue to struggle to identify the underlying causes of the challenges to today’s marketplace.
Click here to read Part I of “Just Calling it HFT Doesn’t Make it HFT” from MMI.