As 2012 peters out, trading activity is slow and market volatility low. Yet this state of relative calm hasn't quieted the anxious chatter about hyper-fast trading by automated systems aimed at capturing tiny price blips in stocks, over fractions of a second.
This is the industry landscape facing Larry Leibowitz, chief operating officer of NYSE Euronext Inc. (NYX), the parent of the New York Stock Exchange and other trading venues. Speaking with us at Minyanville.com's Festivus charity event on Dec. 7, Leibowitz blamed what he called the market's case of the volume "blahs" on general investor hesitancy in the face of open questions on taxes, government budgets and regulation. The bulge in volumes experience during and right after the 2008 financial crisis has been entirely unwound, with average daily trading volume in U.S. stocks now around 2007 levels.
Some unknowable portion of these volume declines is related to individual investors steadily pulling cash from actively managed equity funds --withdrawals only partially offset by inflows into exchange-traded index funds. The public remains wary of stocks after the indexes were twice cut in half between 2000 and 2009, and fears have grown among small investors about computer-propelled trading on privileged access to order flow.
Leibowitz suggested that clearer reporting on the activities of high-frequency traders is necessary to help counter some of the worry about the business and rebuild investor confidence in the public equity markets.
"The reality is, technology is here to stay, and has been a huge windfall for end investors, whether retail or institutional" through lower trading costs and faster systems, he said. "The real question is: How do we regulate and surveil it in a way that gives people confidence that they have a chance?"
Cheap trading technology and regulatory changes in the early-2000s spawned new electronic market systems, some of which catered to automated, high-volume, super-fast trading strategies seeking to profit from fleeting price inefficiencies and barely detectable waves of buy and sell orders.
As Leibowitz says, high-frequency trading — which represents an important source of business for NYSE Euronext and all exchange operators - is simply electronic trading by automated means, one where "a bit of a bubble" arose as the financial crisis created lots of the volatility and volume that such systems are built to feast on.
While in some respects these players were filling a void left by the exit of traditional market makers and floor specialists as those middlemen's profits were squeezed, HFT grew by some estimates to account for more than half of all turnover in U.S. stocks in recent years. The 2010 "flash crash," the botched debut of Facebook Inc. (FB) on the Nasdaq (^IXIC), and Knight Capital Inc.'s (KCG) rogue trading software this year raised further concern about the fairness and stability of our networked markets.
Leibowitz believes the broad public suspicion of the market mechanics - now vexingly complicated, with more than a dozen exchanges and perhaps 50 "dark pool" electronic markets - is based on "more fiction than fact." It's the job of the Securities and Exchange Commission and the industry to help "separate fact from fiction," he adds, pointing to the futures markets' move to tag and report HFT order flow as a good start in tracking potential abuses.
While the SEC has "a full plate" in working to implement the massive Dodd-Frank financial regulation law and undertaking several insider-trading cases, Leibowitz says the agency needs the industry's support in improving market transparency and efficiency.
"We have to take a step back and look at the good and bad in all that has occurred in the last 15 years and figure out how to markedly improve it, without giving up a lot of the good," he said. "We do have an obligation to make people feel it's fair."