Crush, Kill, Destory
Crush, Kill, Destory

It is pretty clear to most everyone that high frequency trading (HFT) destroys market integrity. In recent comments on my blog post, Strongly Regulate High Frequency Trading, Colin Clark shift’s the discussion away from HFT and points the finger at other market fundamentals.  I agree with Colin that there are certainly myriad other problems caused by greedy financial services firms, but those issues are a different discussion, mostly orthogonal to the HFT issue.

John Bates comments in reply to my post are on track, where he says:

“The point I was trying to make is that you can protect investors from some of the rapid movements that HFT can accentuate by having electronic safeguards — like real-time pre-trade risk and real-time market surveillance.”

In order to address this objectively, we need to look at this problem from an information security perspective.  In Infosec, there are three types of security controls:

  1. Logical controls,
  2. Physical controls,
  3. Administrative controls.

John is advocating the application of logical controls (software technology) and cautioning against the use of administrative controls (government regulations).    This is the natural position of most technologists, by the way, and most CTOs would not be CTOs if they positioned otherwise. Their job is to advocate technological solutions, which John did.   There is an old saying, “Where you stand is based on where you sit”.   It is professionally correct to take positions based on where you sit (your position).  You can see John’s considerate reply here.

An excellent 2009 article in the New York Times, Stock Traders Find Speed Pays, in Milliseconds, is quite revealing on the problems with HFT.   Below are a few direct quotes from that article:

“… high-frequency specialists clearly have an edge over typical traders, let alone ordinary investors. – NY Times

“If an individual investor doesn’t have the means to keep up, they’re at a huge disadvantage. –NY Times

“While markets are supposed to ensure transparency by showing orders to everyone simultaneously, a loophole in regulations allows marketplaces like Nasdaq to show traders some orders ahead of everyone else in exchange for a fee. – NY Times”

“… we’re moving toward a two-tiered marketplace of the high-frequency arbitrage guys, and everyone else. People want to know they have a legitimate shot at getting a fair deal. Otherwise, the markets lose their integrity. – NY Times

Basically, the markets has already lost much of their integrity because of these “loopholes” that the NY Times has pointed out.  That is one of the major reasons we see these wild instabilities in the market place that have little do with market fundamentals.   I agree that market fundamentals are certainly influential, as Colin has reminded us, however, the “unfairness” to “normal investors” created by HFT is a discussion that is mostly unrelated to other problems we are seeing.  HFT is a serious problem that undermines market integrity.

I agree with John Bates that logical controls are important.  However, administrative controls are also very important, and generally more important.    There should be a regulatory framework that insures that technology cannot be used to put individual investors at a disadvantage.  Regulatory loopholes must be closed.  When a regulatory framework is in place that does not create unfair advantages to traders based on technology (i.e. who has the fastest gun wins the gunfight), it is certainly possible to use logical controls to help insure that these rules are followed, as John has pointed out.

The reason I responded directly to John Bate’s original post on this topic was not to single out John or Apama.  John is doing exactly what a CTO should do – advocating technology to solve problems.  All technology CTOs who are doing their jobs correctly must do this.  However, since I am not in the shoes of a CTO who has a job selling technology (logical controls), I think it is necessary to point out that administrative controls (regulations, laws, policies and other rules and guidelines) serve as the critical backbone of all security plans.  Having said that, if I was CTO I would also be pointing out the importance of administrative controls as well.  Perhaps that is why I am not a CTO!

As a side note:  I recall before leaving TIBCO Software, my boss told me that “software companies” have no place for independent consultants.

There is no doubt that the loopholes in the stock market regulatory framework creates a multi-tiered system that provides a distinct advantage to firms who invest in the technologies required to win the trading “arms race” game.   This undermines the integrity of the “investor’s market”.   The NY Times predicts that “markets will loss their integrity”.  Many of us believe that has already happened.

In closing, John is correct to point out that logical controls are an important part of the solution.  It is also just as important to point out the administrative controls are important.  In fact, if you look at most information security (and integrity is a part of information security) solutions, administrative controls are often more important than logical controls and they certainly form the framework by which to build the required logical controls.


  1. Tim,

    I’d like to respond to your NY Times quotes and make a comment or two in general.

    1st Quote – Investors shouldn’t really be concerned about this ‘edge’ that HFT theoretically possess. Investors are investing for the long term. Traders typically have much shorter time horizons. Two different goals, two different sets of tactics.

    2nd Quote – If an individual investor wants to wade into the pits and compete against the big guys in trading, market making, etc. then yes, they are at a disadvantage without the latest technology. However, advanced technology is readily provided by most of the online and big brokers (trading workstations, etc.) so this point is effectively moot for the investor and day trader today.

    3rd Quote – This loophole has been closed. This practice, called ‘flash orders’, was short lived. And I agree that it went against transparency and the spirit of RegNMS.

    4th Quote – There’s always been a multi-tiered market. I’ve traded on the inside of that market as a professional and on the outside as a regular, Joe Investor, and have no complaints in either regard. I feel that I’ve always gotten a fair deal. Sometimes, I’ve made trading mistakes and I’ve paid the price for that. For example, I very rarely ever enter market orders.

    The circuit breaker that NYSE implemented during the ‘flash crash’ worked. And other market venues have agreed now to honor NYSE’s LRP. This is good. We’ll see how it works. This doesn’t require any additional software to be purchased from CEP vendors.

    In regards to investing vs trading – these are two separate disciplines and require different tools to be effective over much different time horizons. Traders have always had more tools, more technology, etc. than the average investor – but that’s never really put the investor at a disadvantage.

    So your assertion that HFT creates an unfair advantage and destroys market integrity is still without proof of evidence other than your opinion. These are very complicated matters, and like your areas of expertise which has taken a career to refine and hone, also require a tremendous amount of knowledge and practical application to fully understand. I don’t fully understand this stuff after 25 years in the business and I doubt that anyone else fully does either. Although there are many people who know much more about this than I do and I respect their opinions.

    I will say that it has been my privilege and honor to work with many market venues where rooms full of people have spent countless hours of time and enormous amounts of money ensuring that the market is fair for all participants. Sometimes we made mistakes, we were always quick to correct those mistakes. This is way regulation should proceed slowly – it often has unintended consequences.

    Only by continuously educating the market will people learn that HFT is not to blame for underlying market fundamentals or market structure, and that HFT doesn’t negatively impact the investor’s chances of earning a fair return.

    One final point: I don’t actively sell to the HFT market any more in the areas of order origination or delivery; I do sell software that is used for surveillance though. In fact, what I do now might actually fit more of your definition of CEP – we’re using statistical models, stream processing, threat identification and assessment, and case management-more of the event processing nirvana that David describes in his book.

  2. Nothing operates in a bubble. Doesn’t short term also effect the long term? The results of trading activity by short term traders can cause real damage to a company, so everyone should be concerned about that.

    The financial sector is complicated. no will argue it’s easy to understand. I don’t know about others, but the 2 years I spent working on pre-trade/post-trade compliance made me distrust the financial institutions. To this day I still don’t trust them. Ultimately their goal is to make a ton of money for themselves and a tiny bit for the end consumer. At every turn, large firms will use their political clout to game the system in their favor. That’s been going on for a long time.

    I would argue technology makes it easier for those individuals to abuse the system.

  3. I always find it revealing that the people who are the strong supporters and defenders of financial services (trading especially) and their questionable ethics are the same people who work and profit from the industry.

    Even at it’s best is it a “how can we profit from the losses of other people” industry, for the most part.

    Insider trading in rampant and HFT is simply a technology-enabled way to do insider trading, trading on insider “signals” v. new stories, etc. As Peter said, technology has permitted more system abuse and destabilizes the markets. Few people would argue to the contrary.

    Colin, with all due respects, I found the NY Times article on the issues with HFT significantly more credible than your rebuttals to the contrary.

  4. I think history has shown that many of the people running these large financial institutions have not upheld the highest ethical standards. For example fidelity, putnam, wellington, and bears stearn were all fine around 2004/2005.

    I accept the financial industry works that way. I don’t blame CEP or technology for the crimes that have been committed, but lets be brutally honest. Asking financial firms to police themselves and blindly accepting they will do a thorough job is just asking for trouble. I feel it’s safe to say we are all swayed by our employers to a varying degree. If we’re honest about it, just about everyone has willing gone with the sales pitch at one point in our lives. It’s easy to rationalize it and say “I don’t knowingly associate with liars”, but is that reality?

  5. There seems to be some disagreement here about what “market integrity” actually means.

    The notion of “level playing field” implies that certain forms of advantage are eliminated. The notion of “playing field” implies that certain forms of advantage may still exist – otherwise there would be no point playing.

    For example, some sports are so expensive that only affluent people or well-funded organizations can compete. (Think F1 motor racing, yacht racing, anything with horses.) And in any sport, wealth can get you access to superior training facilities – tennis players with money can fly to Miami when it’s raining at home. But there are still rules that prevent certain forms of unfair practices, and there is still a certain amount of talent involved, so that the outcome cannot be simply predicted from the amount invested.

    High frequency trading may indeed be directly available to some players and not others. If this provides a genuine advantage (and lots of people clearly believe it does, else they wouldn’t invest in it) the question whether this class of advantage destroys market integrity depends on your definition of market integrity.

  6. I thought these quotes were interesting, for example, from Fortune, there is an article called, “High frequency trading: Why the robots must die” with this quote:

    “The regulators and the major exchanges have drifted from their original duty: to run a market that gives small companies a way to raise capital and mom-and-pop stock buyers a way to invest for the future on fair terms.”

    which goes on to say:

    “Instead, they have created a Frankenstein’s monster that churns away for the sake of volume itself, lining the pockets of nimble, technologically savvy hedge funds, giant investment banks and other players – at the expense of market stability.”

    @Richard Veryard, it really does not matter very much how we split-hairs semantically about what is “market integrity”…. Your logic is similar to saying, “I did not have sex with that woman…” because the perp defines sex differently than other people to keep out of trouble. Loophole surfing, me thinks!

    Yes, of course it is good to have better definitions; but clearly it is wrong to have a market where average mom-and-pops can lose their life savings to the whims of trading robots who are situationed next to the exchanges (closer than the others) with clear advantages over the rest of the “players”. Of course, murderers also tend to justify their crimes, so what difference should we expect out of white collar criminals?

    You talk about “some sports are so expensive that only well funded people can complete”…. What in the world does that have to do with the stock market?? The stock market is not a game like F1 racing, yacht racing or anything to do with horses. Where did you get that idea?

    Fortune calls it “Frankenstein’s monster that churns away for the sake of volume itself” in other words, an evil beast.

    Bravo Fortune!


  7. @Colin, If you are not going to read my blog, then you better not read Fortune, the NY Times, and all the other authors and writers who call the current market conditions “A Frankenstein’s Monster”.

  8. F1 analogy feels a bit odd to me. If danica patrick wins or looses, it doesn’t affect my 401K. If hedge funds behave in unethical ways, which impact the stability of the market, my 401K takes a hit.

    One could argue a significant percent of the world population has been negatively affected by unethical behavior at some of the top financial institutions. I get the feeling some people in the financial industry think of it as a game, but it’s not. Real money is lost and real people are hurt by it. I’m not against high frequency trading, I just think it should be open and affordable to everyone or to no one. Clearly that’s never going to happen, so we have to live with the fact that people with the power and money to do HFT are also the people most likely to abuse it.

  9. Hi Peter,

    Richard’s sports analogy has a logical flaw, as you mention. From my comment on LinkedIn (double posted here):

    Richard’s model, in my view, was mistaken because he compares sports directly with the stock market. The proper analogy, it appears, is to compare the stock market to the parimutuel betting and gambling associated with sports. The reason for this is that, just like the stock market, gambling and betting permits individuals who are not directly “in the sport” to participate in the sporting events. These “passive-participants” win-or-lose based on the actions of the players and teams in the actual sport. At the “playing field” level, the direct comparison for a F1 racing team (or a horse racing team) would be companies, like Nokia or Apple, who compete head-to-head.

    As we know, sports betting and gambling is highly regulated.

    Of course, the stock market is generally broader in scope than betting, since the market is used to raise money for company operations and other business fundamentals. However, the analogy to compare the markets directly to sports is flawed, in my view, and if we were to create an analogy, it would need to be to compare the stock market to sports betting and gambling, a highly regulated, and often illegal activity, where insiders who use their insider skills and knowledge to profit from others without the knowledge or skills are generally banned from the sports.

  10. I think this is sometimes a religious war.
    There a fundamental reasons for HFT – namely the spreading of liquidity over market places for the same and similar securities. So for stopping HFT totally the fundamental reasons need to be fixed. There are some easy things like transaction limits which can fix a lot of issues, but the exchanges and other parts of the industry make huge profits from HFT and lobby for it.

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