How HFT ruins markets

Posted by Jeff Carter
on June 25th, 2012

Funny, everytime I put a big order in on the screen, an order immediately jumps in front of me. Everytime.

It’s a computer program. Some algo. When I cancel the order, the front runner goes away. When markets spin out of control in a flash crash, or flash rally, I never get filled at the top or bottom of the range. An HFT order jumps ahead of me.

But I can just about guarantee that whenever I put a big stop order in the market I will get filled as algo’s go sniffing for them.

Is this what we want electronic trading to look like? It remimds me of the Pork Belly pit. The bellies were a great trade until the market moved away from them as producers began using fresh versus frozen bellies. So many people played so many shenanigans with the market intraday that the retail trade left. Eventually, the contract died and there is no centralized marketplace to hedge risk. It’s one of the reasons the cost of bacon is higher than it used to be.

We are in danger of reliving the same thing in grains($ZC_F, $ZS_F, $ZW_F), hogs($HE_F) and cattle($LE_F). These are necessary marketplaces that allow users of the market that are exposed to markets transfer risk. Without them, they have to go to the underground OTC market to hedge. That decreases market transparency, and only benefits huge arbitragers that can price one market against the other.

The end game is that all prices will be higher because it won’t be as cheap to transfer risk.

Currently, the exchanges ($CME, $ICE) are deaf when it comes to thinking about structural changes in the marketplace. All they can see is the almighty dollar. They are misinterpretating the volume. Liquidity hasn’t been enhanced in ag markets. It’s short sighted. But businesses aren’t known for taking the long view anymore. They are prey to quarter by quarter earnings.

Regulators are deaf and dumb too. Either they are populated by a revolving door of personnel that have companies benefitting from the anomolies in the market, or they have career government people that were appointed there and don’t really understand the structure of the marketplace.

The end game is the retail investor and consumer will get screwed. Prices will go higher, and faith in competitive marketplaces will be permanently damaged. There is enough technology out there, and enough innovative minds to create a better way. The way we are structuring the marketplace today is killing it.

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