The stock market isn’t rigged, but it is taxed.

It always has been. As Justin Fox points out, for as long as people have been trading stocks, there have been middlemen taking a cut of the action. Now, that cut has gotten smaller as markets have gotten bigger and more technologically-advanced, but it’s still there. It’s the implicit fee that intermediaries charge for making sure there’s a buyer for every seller, and a seller for every buyer—for “making markets.”

But there’s a new kind of middleman today. They don’t work at stock exchanges or banks. They work at hedge funds, and trade at whiz-bang speeds. These “high-frequency traders” (HFT) use computer algorithms—a.k.a., algobots—to arbitrage away the most infinitesimal price discrepancies that only exist over the most infinitesimal time horizons. You can see just how small and how fast we’re talking about in the chart below from a new paper by Eric Budish and John Shim of the University of Chicago and Peter Cramton of the University of Maryland. It uses 2011 data to show the price difference between futures (blue) and exchange-traded funds (green) that both track the S&P 500. These should be perfectly correlated, and they are—at minute intervals. But this correlation disappears at 250 millisecond intervals, a little more than half the time it takes to blink your eyes. This is the “inefficiency” that HFT makes less so.

http://www.theatlantic.com/

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Fears that high-speed traders have been rigging the U.S. stock market went mainstream last week thanks to allegations in a book by financial author Michael Lewis, but there may be a more serious threat to investors: the increasing amount of trading that happens outside of exchanges.

Some former regulators and academics say so much trading is now happening away from exchanges that publicly quoted prices for stocks on exchanges may no longer properly reflect where the market is. And this problem could cost investors far more money than any shenanigans related to high frequency trading.

http://www.reuters.com/

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There’s been recent debate on High Frequency Trading (HFT) offsetting traditional SIP trading protocols. The difference is due to technology, HFTs have access to direct feeds from various exchanges, SIP takes time to aggregates various exchanges’ order books. The claim that HFTs are able to front people is faise as the order is already in the market before the HFT can see it. HFTs never know what a customer’s order is before it’s in the market. HFTs have no customers. Just because it is fast doesn’t mean HFTs are cheating. This information is public and available to anyone willing to overcome the challenges of acquiring and processing it very quickly. This is just a case of technology overcoming an existing challenge within the industry or rather seeing an opportunity which is perfectly legal, safe and taking it. Much of the confusion around HFTs derives from a complicated market structure that makes perfectly legitimate behavior seem predatory to the uninitiated.

Just like in the mid-1800s, Paul Reuter created a network of carrier pigeons to more quickly disseminate news. His biggest customers? Financial firms, who predictably abandoned pigeons with the advent of the direct telegraph. The HFT is similar.

There is room for improvement in US and global equity market. The kinds of improvements that need to be implemented are mostly incremental: making the NBBO real-time, enforcing rigorously against any unfair advantage given to any participant, getting rid of the ban on zero-spread (i.e., locked) markets. These changes will improve transparency and reduce complexity. The HFT helps us push toward positive reform.

There are legitimate and interesting concerns about conflicts of interest, free rider problems and market integrity that need addressing. But these issues have nothing to do with HFT. So, even as we strive for improvements, we should try to understand that we have never in our history have seen a more level playing field in any equity market. Especially in a time when large equity firms like Warren Buffet enjoy a myraid of advantages that we’re okay with, this is a positive development.

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On February 12, 2014, starting at 13:31 and running right up to market close, a high frequency trading (HFT) algo placed and canceled 5,000 to 30,000 orders per second in individual stocks and ETFs. Many seconds had more than 20,000 bogus orders.

There were 30 symbols affected: all beginning with the letter ‘O’, ‘P’, ‘Q’, ‘S’ or ‘T’. Not all stocks were listed on the same exchange, but as far as we can tell, these blasts of extreme quotes all had Nasdaq as the reporting exchange, which in interesting in light of the recent statement Nasdaq issued about the cause of the August 2013 blackout (more than 26,000 quotes per stock per second).

http://www.nanex.net/

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