Now that everyone’s stopped freaking out that that “the uncontrollable machines” are taking over (or literally KILLING) the market, let’s look at the arguments that HFT exacerbated the crash Thursday.The arguments against HFT can be summed up in three points.
In hindsight, it’s ridiculous that regulators even allowed these arguments to stick, but at least it exposed what a problem it is that officials still don’t regulate or even understand 60% of market volume.
Argument #1: The initial fear of machine take-over.
WaPo: “I’m talking about what “Terminator” fans would call the Rise of the Machines: automatic, untouched-by-human-hands trading.”
Wrong. Humans design the algos. There’s also manual override. Humans are there to monitor what the algos are doing and all they have to do is push a button and “deactivate” the algo. So it’s not like humans couldn’t stop their algos from selling.
Argument #2: HFT “exacerbated” the market crash.
NYT: “The old system of floor traders matching buyers and sellers has been replaced by machines that process trades automatically, speeding the flow of buy and sell orders but also sometimes facilitating the kind of unexplained volatility that roiled markets Thursday.”
We don’t know what happened Thursday. The market has never seen that sort of volume volatility. So we can’t yet put the blame on HFT in particular.
Argument #3: The market didn’t crash because the algos traded (or sold) too much, the market crashed because they all pulled out and we usually rely on the liquidity they provide.
WSJ:“Market participants say some high-frequency firms pulled back as the speed and extent of the decline went outside their models, which are generally based on the market behaving in a normal fashion.”
This argument suggests that HFT should be required to stay in the market and continue to provide liquidity as designated market-makers. Until now HFT has not been considered a market-maker. HFT is in many cases a part of prop desks that decide themselves when and what they want the algos to trade. In other cases they are already part of market-making trading desks that continued to trade on Thursday.
Right now there aren’t any tracking systems in place to monitor high frequency trades. Hopefully there soon will be records that explain what’s happening to regulators, because the SEC recently approved Senator Kaufman’s proposal to “tag” high volume trades (read more about that here). But right now there aren’t and we don’t know how or when they’ll be enacted — or if they’ll really help.
Basically, all we know now is that Thursday’s market crash exposed a structural problem. At the root of it: around 60% of market volume is unregulated and misunderstood.
Now Senator Kaufman has proposed a timeline by which the problem must be discovered and a solution proposed. His timeline is 60 days, so it’s possible that understanding might a while.
Until then, here is one possibility of how it will be solved, from BTIG’s Brett Mock, who used to be President of the San Francisco Security Traders Association:
“I think the marketplace needs a unified rule and that the current erroneous trade policies are not adequate. Technology and competition have decreased transaction costs and improved efficiency…but investors need to be able to trust the market structure.
“cancelling trades or taking trades off the tape after the fact compromises market structure integrity. The US equity markets performed incredibly well during the 2008 melt down and the principles of this market structure still hold: transparent prices, centrally cleared trades/limited counterparty risk, and ample liquidity. We need to fine tune some of the regulations but I don’t think wholesale changes need to be made….Yesterday clearly shows however, there needs to be a market-wide trading halt/ clearly erroneous trade policy.”
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