Thursday, February 23, 2012

SEC May Ticket High Speed Traders

Apparently, the Securities and Exchange Commission (SEC) may start charging fees to curb high frequency trading. In this Wall Street Journal article, Mary Schapiro said the following:

...a large portion of equities trading has little to do with "the fundamentals of the company that's being traded." She said it had more to do with "the minuscule aberrational price move" that computer-assisted traders with direct connections to the exchange can "jump on" in fractions of a second.

In addition to forcing traders to pay for cancelled trades (it turns out cancelled trades make up something like 95 to 98% of orders by high-frequency traders), the SEC may impose a requirement on high-speed participants to maintain competitive buy and sell orders throughout most of the trading day.

According to this article, Schapiro's concerns were sparked by the "flash crash" back in May of 2010.

That article points out that the SEC's mission is to "maintain fair, orderly and efficient markets" and to "facilitate capital formation." It seems to me that most high-frequency trading activity adds little value to the capital formation process and, if anything, might be one of the reasons we've seen record volatility. 

In it's current form, whether high-frequency trading somehow helps "maintain fair, orderly and efficient markets" seems at least debatable.

The article points out the crash is a challenge to the SEC's stated mission.

...to "maintain fair, orderly and efficient markets" and to "facilitate capital formation." If investors are afraid of a market crash, in other words, they won't provide the capital that public companies need to expand their businesses.

According to Schapiro, the SEC has implemented some fixes since the flash crash including:

-Circuit breakers for stocks that have large moves in a short period of time.

-A ban on stub quotes (offering to buy/sell far from what most investors are willing to pay...a contributor the the flash crash).

Some questions come to mind:

Will the fees on cancelled trades be substantial enough to actually change high-speed trading behavior?

Will the requirement to maintain competitive buy and sell orders for a certain percentage of the trading day change behavior?

In what time frame will the changes be implemented?

Are other solutions being considering to curb the influence of high frequency trading?

Just a guess but those involved in high frequency trading will likely not think these fees and other changes under consideration are such great ideas since, of course, they'll have adverse effects on "liquidity".

Well, I think we can stand for a bit less liquidity and a bit more actual investing. Charlie Munger said it best. He doesn't see much benefit to the massive amount of trading between computers that goes on. He also doesn't seem to think the energy expended and talent utilized writing algorithms (that ultimately the rest of us pay for) provides much social contribution.

"...why should we want to encourage our brightest minds to do what amounts to code-breaking and electronic trading? No I think the whole system is stark-raving mad. Why should we want 25% of our graduating engineers going into finance?" - Charlie Munger

Munger: Cut Banking Sector 80%

The economics of high frequency trading will have to be fundamentally changed for this to work in the long run.

It's not like this is static.

In other words, adjustments by high-speed traders will naturally be made to try and thrive under whatever the new rules end up being.

Adam

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