Friday, February 14, 2020

The "Myth of Latency Arbitrage"? If You Believe That Expect To Be Taken By The Market's Flash Traders.

Author Michael Lewis ('Flash Boys') described in detail back in 2014 how flash traders- using the high frequency trading (HFT) gambit are able to see milliseconds ahead of your buy orders to get there before you can, buy the stock and raise the price.  In a way it's  kind of tax on your transactions, so you don't come out as far ahead as you thought. Also, the same applies to sell orders. They can get there first, and you get much less than you originally thought you would.

Lewis - in connection with a book tour- emphasized the flash traders often traded on fractional share values but these inevitably pile up. Billions could be made off the backs of poor ordinary day traders, who trusted that when they placed their buy or sell orders no shenanigans or secret advantages were afoot. But alas, this isn't the case. It only takes a tiny fraction of a second of a flash trader's advantage (i.e.  a delay or "latency" for you)  for them to see slightly ahead - to what you're intention is - and do it before you do.

Now we learn ('High Speeds Seen Increasing Costs Of Stock Trading', WSJ, Jan. 28, p. B1) we're expected to believe that "latency arbitrage" (the process by which HFT greases the stocks wheels for the few) is a "myth" and circulated for political reasons.  This put forward by Kirsten Wegner quoted in the piece who is an HFT specialist with Modern Market Initiatives - a bunch that promotes flash trades.

Here's the skinny you ought to know (ibid.):

"High frequency traders earn nearly $5 billion a year by taking advantage of slightly out of date prices, imposing a small but significant tax on ordinary investors."

This according to a new study by the UK's  main regulator, the Financial Conduct Authority (FCA).   The practice goes by the name "latency arbitrage".

"Latency" meaning the delay in time - often fractions of a second (hardly "out of date" as the WSJ describes it) so that the HFT guy can gain an advantage - enough so that by the time the ordinary run of the mill investor buys or sells it's already at markedly lower prices.  In other words, if you also don't use HFT you lose.  (Though one professor cited from the Univ. of Chicago's Booth School Of Business claims that the losses imposed for ordinary households are minor. )

He also says the HFT set already have to pay higher costs on their trades.  Well, yeah, ok, but those losses may add up to a few hundred million bucks while they're still raking in over $4 billion extra a year off the hides of ordinary blokes..

But this is why politicians in both the U.S. and Europe - including Senators Bernie Sanders and Elizabeth Warren are pushing for a financial transaction tax, "a policy aimed in part at curbing high speed trading".

The tax will be only a few cents on each dollar traded but because the HFT can do thousands of transactions per second, the  tax hit on them will clearly be bigger than for the small fry ordinary investors- who may make only one 'call in' or online trade a day - or per hour at most.

All of which shows the experts cited in the piece who say  "latency arbitrage raises costs for (ordinary) investors  by making everyone in the markets less likely to post competitive price quotes for stocks" is correct.   I mean why would you willingly lowball yourself if some HFT hotshot is getting ready to rip you off using fast trades?  I.e.

Why do so,  "knowing that those quotes will get picked off  by the fast frequency trades."

Proving again the stock market is a rigged game unless one has the same 'weapons'  or systems as the high frequency traders.  Or plenty of disposable income to be able to afford the inherent disadvantages over time.

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