HFT investigated by regulators, trading abuses evolve

I have raised the alarm in previous columns about high frequency trading and the threat it poses to fair, transparent markets. This week, I have some good news.

Both here and around the world, regulators are beginning to develop ways to track HFT and assure its traders are obeying the law. The immutable laws of the marketplace are also beginning to reduce the impact of HFT.

A brief recap: HFT uses computer algorithms and proprietary strategies to make thousands of security trades in fractions of a second. Until recently, HFT was virtually unregulated, and no one really knew how it affected markets and the average investor.

We did know that many investors were spooked by the high profile market breakdowns attributed to HFT, including the “flash crash” of 2010, the debacle surrounding the Facebook IPO in 2012 and the computer glitch that shut down BATS Global Markets, our third largest stock exchange, in 2012.

Those and dozens of other less publicized, but still serious, HFT-related market disruptions finally caught the attention of financial regulators. Last October, the SEC hired Tradeworx, an HFT-savvy New Jersey firm, to open up its sophisticated computer program to regulators.

As the New York Times reported at the time, “This will give the SEC its first real-time window into the stock market – something firms like Tradeworx have had for years … It could enable regulators to detect whether trading firms are overwhelming the market’s plumbing when they rapidly submit and cancel orders.”

The Tradeworx program is now producing revealing data that circulates throughout the SEC.

The Financial Times recently reported the data is being shared with the FBI to help determine any market manipulation by HFTers. The CFTC has also deployed its own system to monitor what is going on in the markets it regulates.

Regulators around the world are now actively investigating HFT. Most prominently, France has introduced a financial transaction tax to deal with short-term speculating.

A report on the results produced by the University of Memphis found that while there was an initial decrease in volume in the first month, it quickly came back to near normal. There were no real negative effects.

This may give some impetus to a bill proposed in this Congress by Sen. Tom Harkin (D-Iowa) and Rep. Peter Fazio (D-Ore.) that would impose a .03 percent tax on almost all trading in U.S. markets. As insignificant as this tax would be on even large block trades, it would certainly discourage HFT.

The HFT share of the market is beginning to fall. Rosenblatt Securities reports that the HFT share of trading in our financial markets has fallen to 50 percent from its high of 65 percent in 2011. In large part, this decline is the result of applying principles learned in Economics 101. It was clear on the Street that HFTers were making a fortune, so lots of new players hired computer whizzes and got into the business.

Any industry with very high profits that is easy to enter will inevitably encourage competition, leading to a decline in profits for everybody. Profits from HFT trading have plummeted to $1 billion last year from $5 billion in 2009.

According to Raj Fernando, head of HFTer Chopper Trading, “The margins on trades have gotten to the point where it’s not even paying the bills for a lot of firms. No one’s laughing while running to the bank now, that’s for sure.”

Never underestimate Wall Street’s resourcefulness. If they can’t make much on HFT trades anymore, they’ll find another way to use those super fast computers.

The latest wrinkle is called “news-feed trades,” and it involves getting advance news of market-moving data from non-governmental sources. The University of Michigan consumer-sentiment survey, for instance, is widely respected and often influences the stock market the day it is released.

Back in March, a few HFT traders made a bundle because they had bought and knew the results of that survey two seconds before anyone else.

There’s no law against that right now. But there should be.

It just goes to show how extraordinarily difficult it is to keep up with trading abuses in an increasingly complicated digital age.

We have to keep trying though, if we are going to protect individual investors and have the kind of honest and transparent markets that were once the envy of the world.

Ted Kaufman is a former U.S. senator from Delaware.