Breakout

5 steps for cleaning up high frequency trading

Jeff Macke
Breakout

Lost in the umbrage, outrage and fighting over “rigged” markets and High Frequency Trading is much conversation over the market-making function and how it should be rewarded. There seems to be a general consensus that heads must roll and cheating is happening but there hasn't been much conversation about what the precise problem is and how to solve it.

The institutions maintain, correctly, that HFTs are front running trades. Individual investors who bother to fully grasp the situation are left wondering why they should particularly care if institutions pistol-whip one another for fractions of a penny.

Individual investors live in a world of fast fills and $8 trades. For all the howling over the ‘Flash Crash’ it's still not apparent why exactly it happened and why it mattered when seen from a distance of more than a few weeks. The market fixed itself. Capitalism works.

The challenge of being at once wised-up about the market being fixed and apathetic about HFT in particular seems to have proven to be too much for the bloodthirsty masses.

Knock yourselves out. The regulators are going to arrest people and nothing much will be changed. In the meantime, for those looking to make the financial world a better place, Jon Najarian of optionMONSTER  has taken 3 minutes to offer a five-step solution to the high frequency trading problem that's been building for 10 years and a concern of financial regulators for the past 5 days.

1 - Stop releasing material information ahead of time. Embargoed, sold or otherwise released. Let everyone hear the news at once.

2 - Penalize front-running. This is a little fuzzy. Positioning yourself to gain from financial moves is the essence of trading. Regardless if the government is going to go 80-0 on insider trading cases without having a firm definition in place penalizing an algo that front runs a 500,000 block of Intel (INTC) shouldn't be too hard.

3 - Stop cutting up spreads and commissions. Dr. J says the lower limit should be one penny. Think of it as a natural throttle and regulator on speed trading.

4 - Transparency. All bids, asks and fills available for everyone to see.

5 - Bring back market-makers to provide liquidity as a last resort. Pay them for filling the role. It’s an idea of pure genius in its retro spirit.

That's it. Link to this page for Monday when HFT has fallen off the front page and back into the swamps of Jersey.

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