The Exchange

Blame the High-Frequency Traders for Yesterday’s Nasdaq Mess

The Exchange

By Jon Najarian

Some want to focus on "legacy" issues as to why the Nasdaq asked for that trading halt yesterday. This implies that the Nasdaq simply can't keep up with the pace of technology, or is forced to used "old pipes" to distribute its market data.

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While both could be part of the problem to some small extent, they are not the root cause. The real issue is something no exchange wants to discuss and, in fact, may be legally unable to discuss under non-disclosure agreements. Whatever the case, it has resulted in the Rube Goldberg system that keeps dollars flowing into exchange coffers via tape revenue while catering to high-frequency trading firms (HFTs) that enhance volumes.

An unfair market

Note that I said enhance volumes, not liquidity. Higher liquidity has been the argument that the exchanges use to justify systems that benefit HFTs. To wit, who among you would think that there should be three tapes (NYSE is Tape A, Amex is Tape B, and Nasdaq is Tape C) to deliver "live quotes" to market participants? Who, other than Rube Goldberg himself, would design a system that shares a portion of the revenue derived from the sales of this data with HFTs? Who would have thought that it's a good idea to let HFTs clog these data pipes with bids, offers, and canceled orders in millionths of a second in an attempt to get paid for providing liquidity rather than taking liquidity?

There are so many questions as to why, but each comes back to this: The markets are not set up to be "fair and orderly" for investors; they are set up for the benefit of very fast, sophisticated pickpockets.

Consider yesterday's outage and the idea that it was a "market participant" who took down the Nasdaq's ability to disseminate quotes. This participant is likely to be a very large firm that the Nasdaq didn't want to lose as a customer along with all the tape revenue that it generates. So the "market participant" remains nameless, because if named and thus shamed by the Nasdaq, this customer could simply shift over to the NYSE and take hundreds of millions of tape revenue with it.

As Eric Hunsader of Nanex regularly points out, each time the exchanges increase the size of their pipes to handle more data, Wall Street tops out the capacity. I believe that they fill the pipe to slow the ability of those who don't have colocated servers from seeing what the "real" market is at that nanosecond. That, my friends, is cheating at best if not fraud.

It's not liquidity, it's stealing

And I'd be remiss if I let the HFT defenders say that they offer "real" liquidity. That is simply not true. All you need to to is review the Goldman Sachs 17-minute debacle just days ago. Where was this alleged liquidity when GS sold all those options down to a buck? I show block after block of options start hitting at $9 or $4 in 20-contract lots, and then cleaned up say on average 900 contracts at a dollar. I suspect that the HFTs saw the big prints hitting, and in a nanosecond's time dropped their bids, accommodating those Goldman sales down at a buck.

Some may call that liquidity. I call it stealing!

I hope the SEC, CFTC, and FINRA get on this NOW rather than sweeping these two recent incidents under the carpet. The skew towards HFTs and other sophisticated high-speed trading systems, rather than maintaining a fair and orderly market, must be addressed urgently to keep our financial markets the most robust on earth. If not, we will cede that status, and it will be a sad day for America.

Jon Najarian is co-founder of Optionmonster.com.

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