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Liquidnet's Seth Merrin On HFT: "We Have Shifted From An Investor's To A Trader's Market"
Lately, in the aftermath of the Flash scandal, as more and more attention has been vested into broader market landscape issues such as High Frequency Trading, there has been a spirited defense of HFT, which traditionally goes along the lines of: if it provides liquidity, it tightens spreads, it must be good. Just look at the NYSE's own blog for a version of this.
Yet, is it as simple as that?
In an interview with Advanced Trading, Seth Merrin who is the founder of Liquidnet, the largest buy-side only dark pool, provides some salient arguments for the contra view on HFT.
Before getting into HFT, Seth is quite vocal in his condemnation of Flash orders:
While high frequency trading as a category has its pros and cons, like all trading, but flash orders have absolutely no pros, says Merrin, an advocate of the institutional investor.
This is an example where again— typical of Wall Street— there are a few that benefit at the expense of many
Whenever there is a crack in the armor or someplace where you can make a lot of money, Wall Street figures it out very quickly and that's where they go.
While flash orders are used to give a sneak peak at order flow to participants on a private network so they can match a trade before routing out to a public market, Merrin says this is no different than an institution giving an order to a broker and finding out that the broker relayed the order to different hedge funds. "What would you do with that broker?" asked Merrin.
The last statement is actually very pertinent, as it indicates substantial analogies that can be extracted between a generic critique of Flash orders, and how bond and CDS sales and trading desks operate when providing staggered looks for order flow to preferred clients (while their own prop traders who sit feet away (and have first dibs on every bid and offer) are consistently privy to every nuance of overall trade flow). In fact, this will be a major focus point on Zero Hedge soon as we demonstrate some historical and concurrent findings in something as simple as the physical layouts of Broker-Dealers' trading floors (particularly those who have a prop trading operation), and how physical proximity with Chinese walls absence, provides BD's with the potential to make off like bandits by trading wide-spread Fixed Income products, without any regulatory intervention. One argument is that the contemporary Chinese Wall should be erected not between the Sell Side and Corp Fin, as nobody cares what sell side researchers have to say anymore. It should be between Flow and Prop traders at major investment banks-BHC's-government backstopped hedge funds. As for Merrin's question of what one would do with such a broker - the truth is that in the aftermath of the Lehman and Bear collapse, institutions have very few options in deciding who their primary relationships are with, especially since secondary inventory is focused at a very few key B/D's.
Continuing with Merrin's observations, he moves from a uniquely negative opinion of Flash to a muted one on HFT:
Of greater concern to Merrin is the idea that high frequency trading has become the majority of the market. According to Merrin, there haven't been enough studies done on the impact of high frequency trading, which has become the majority of the market. "What we have to recognize is that the market shifted in the last two years very significantly," he said. Traditionally the market has been made up of retail investors, institutional investors and market makers that facilitated these investors, he continued. "Today you have a whole new category which is high frequency trading, now making up 70 percent of the trading in the market according to some analysts," he noted. Two years ago, it was only 30 percent of the trades, so there's been a significant shift, emphasized Merrin. What's more, venture capital firms are funding the start- ups of high frequency trading houses, he noted.
So we've shifted from an investor's market to a trader's market," said Merrin. "Clearly that has implications that people have to understand and think about," he said. He compared what's happening in equities to the commodities markets, where a bunch of energy traders moved the price of energy, not because of supply and demand factors, which is what usually moves commodities prices, but because of speculation.
"There could be a fundamental disconnect between the investor who takes
a look at the fundamentals of the company or the industries they're
investing in and the second-by-second traders who simply take a look at
what's going on in that trading range. If the disconnect happens, that
is going to affect how the rest of us, the institutions and the retail
investors can invest going forward."
And this, ladies and gentlemen, is a well-phrased summation of numerous concerns against the implications presented by HFT: in its ubiquitous creep to market topology domination, over the past several years, the market has shifted from one rewarding fundamental (and technical) analysis and a long-term vision of equity appreciation, to one which benefit only and exclusively short-term (intraday) speculation. Is it any wonder why the bulk of funds end each day in a 100% cash position and why only gamblers find relish in the casino the equity markets have become? Buy and hold is dead, but not for the reasons Warren Buffet would like you to believe.
As to the liquidity provisioning and spread tightening argument? Merrin had this to say:
While industry analysts have said that high frequency trading is the next evolution of market making and adds liquidity to the equity markets and has narrowed spreads, Merrin said he would not put high frequency traders in the same category as market makers. He offered the example of Nasdaq having 4,000 listed securities, but ECNs are effective in the top 300 names. Still, the industry needs market makers in the bottom 3,700 names, he said. "High frequency trading is primarily in the largest most liquid names. What we need is capital provided in the least liquid names. They can't make money in the least liquid names. So are they providing the same services to the market as market makers?" asked Merrin. "The answer is no," he asserted.
Additionally, high frequency traders are not subject to the same regulatory structure and rules where they are required to make markets. "They go where the liquidity is and the opportunity is and they leave where the opportunity is not," said Merrin.
From this perspective, the whole liquidity provisioning argument is not merely flawed but highly hypocritical - HFTs are like rogue scalpers that move from stock to stock (check out the post yesterday about 5 names accounting for 30% of the NYSE's volume), where the liquidity is, in effect removing liquidity from where it actually needed, until such time as there is no incremental capit6al that can be extracted, and subsequently moving on to other sectors. And all this occurring without any regulatory capital or risk requirements of HFTs, pretending to be market makers.
Granted, Merrin's partiality and his professional afiliation shows when he discusses dark pools and the need for dark liquidity:
As regulators examine some of the changes in market structure, Merrin said what he's afraid of is that they could say to get rid of dark pools, without understanding the benefits of dark pools. "Our job is to create a safe environment for the institutions," said Merrin, who operates the largest institutional pool of liquidity for buy-side institutions to trade anonymously to reduce market impact. Having one central pool of liquidity where everyone has to go and trade, is not conducive because there are too many competing interests in one location, he insisted, adding that's why there is a need for alternatives.
Indeed, dark pools have provided many benefits to liquidity seekers over the years. One is the gradual phase out of VWAP algorithms in open markets in favor of child order algo execution in dark pools (alas it is still prevalent: we reference the numerous posts on Zero Hedge indicating VWAP reversion day after day, especially in light of disappearing market volume). Yet, several potential abuses of advance looks linger in dark pools, such as actionable IOIs and other market tiering mechanisms, which as in the HFT case, present the case of a developing scenario where the "privileged" few benefit from the numerous others. And as Merrin concludes of HFT, the same can be noted about virtually all other verticals of the contemporary market landscape:
"The more money that's chasing this high frequency trading, the more they're going to have to do it at the expense of somebody else, and I'm just afraid that expense seems to always come out of the institution's pocket."
And in the spirit of keeping informational context alive, we present the fact that Liquidnet's own control of institutional trading has collapsed by over 22% year over year (34% for July). We would not be surprised if their market loss is the gain of such dark pools as Sigma-X. Zero Hedge will attempt to discuss this angle with Seth in the near future.
The challenge before regulators, politicians and anti-trust commissioners with regard to all these very salient issues is greater now than it has ever been in the history of a "free and fair" equity capital market. Whether the approach taken is one that will perpetuate the dominance and the increased profitability of a select few or will bring back a sense of democracy and remove the highly speculative element Mr. Merrin discusses, will be critical for the future of US capital markets, and the participation of retail investors in what was once the only way to reward success and punish failure. But then again, the last two seem to be no longer a key concern for the administration, which has taken a sharp detour from the primary tenets of the capitalist system that over the past 200 years managed to make America the greatest country in the world. We hope the right choice is made for the sake of continuing America's greatness, even if it means one quarter where a company like Goldman Sachs has more than 2 trading days of capital loss.
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Thank you for banging the drum on this issue. HFT is at the core of all markets issues today: good or bad, it needs to be radically evaluated in light of what is, by everyone's admission, a broken market.
Let´s do this....
The ¨market¨ could be domiciled in any country....
In order for globalization to work....this means that the securities name transfer highway must be both worldwide and unencumbered in any way....
Of paramount importance....notice the word ¨public¨....
¨Public¨means ¨public¨....a public product traded on an equal access.....non-gameable exchange highway....
Not encumbered by taxes or fees.....
An exchange is now just a first come first served time electronic stamp machine which secures the owners label´....
What does this mean ? DEFRAGMENTATION of the markets....
All out in the ¨public¨open....
No internal matching....no black pools....no electronic front running of any kind....Anyone caught otherwise would be banned from trading as a firm or individual....period....
Quite frankly....with all of the legal largesse nonsense in the US....capital would be far more efficient with another domain....which by the way is no problem....as has been proven by BATS....
The exchange should be located where least encumbered....
your currency to keep from , pumping an trillion/year of printed money for the next 10 years or so seems the way to do it.
good articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions
"He compared what's happening in equities to the commodities markets, where a bunch of energy traders moved the price of energy, not because of supply and demand factors, which is what usually moves commodities prices, but because of speculation."
Why doesn't ZH (ie, one of the TD's) write more about systemic issues in the commodity markets? I guess ZH just don't have that expertise in its band of 40?
Then again, I'm sure whichever TD picked up that fight would get it all wrong. Which raises an important question, what exactly is ZH/TD trying to accomplish? If its a "fair and level playing field" I'm all for it, but does that mean ZH is pro-regulation (gov't intervention) or anti-regulation (Ron Paul libertarianism)?
It's a legitimate point of confusion.
It'll remain a trader's market until short term gains goes much, much higher....
David Rockefeller Quote
"We are grateful to the Washington Post, The New York Times, Time
Magazine and other great publications whose directors have attended
our meetings and respected their promises of discretion for almost
forty years."
"It would have been impossible for us to develop our plan for the world
if we had been subjected to the lights of publicity during those years.
But, the world is now more sophisticated and prepared to march towards a
world government. The supranational sovereignty of an intellectual elite
and world bankers is surely preferable to the national
auto-determination practiced in past centuries."
Caveat emptor...especially Goldman clients.
David Rockefeller Quote
"We are grateful to the Washington Post, The New York Times, Time
Magazine and other great publications whose directors have attended
our meetings and respected their promises of discretion for almost
forty years."
"It would have been impossible for us to develop our plan for the world
if we had been subjected to the lights of publicity during those years.
But, the world is now more sophisticated and prepared to march towards a
world government. The supranational sovereignty of an intellectual elite
and world bankers is surely preferable to the national
auto-determination practiced in past centuries."
Henry Kissinger Quote
"Today Americans would be outraged if U.N. troops entered Los Angeles to restore order; tomorrow they will be grateful! This is especially true if they were told there was an outside threat from beyond whether real or promulgated, that threatened our very existence. It is then that all peoples of the world will pledge with world leaders to deliver them from this evil. The one thing every man fears is the unknown. When presented with this scenario, individual rights will be willingly relinquished for the guarantee of their well being granted to them by
their world government."
-Henry Kissinger, in an address to the Bilderberg Group meeting at Evian, France, on May 21, 1991. As transcribed from a tape recording made by one of the Swiss delegates.
This entry shows how out of touch ZH is: ZH is a bunch of petit bourgeois cryptofascist traders. Who cares what happens to this scum?
The "market?" There is in fact no market. Merrin argues a contradiction: somehow corruption has destroyed the market, but there remains some mythic "market" which can be restored.
This is snake oil. What is Merrin's agenda? He certainly has a secret one. Patriotism is the last refuge of a coward, and his appeal to patriotism shows US that HE won't show his hand.
Hitler did the same thing: blabbing on and on about democracy and the market until HE got into power and installed the corporatist state.
And notice that this fool Merrin says nothing about the corporatist state we have now in America in everything but name.
Can't you wait until this whole thing collapses and wipes people like Merrin off the map?
Good points on order flow. This will not be fixed until all the hops from your trading software to the exchange and then to the back office are provided by bonded entites audited to be free of their own principle market interests and informational resale services. This is a winner take all game and the current order flow structure provides irrestible opportunities to gain an information advantage which could be used to squeeze your position or other aggregate market groups' positions.
The emergant behavior of a dominant HFT meta-strategy could explain much of the 'fundamental disconnect' market rally. I have created some behavior models of support/resistance faders vs momentum traders, setting of stop losses for each strategy, change in belief about which market/technical theme is dominant, and a couple more and this ecosystem can result in strange outcomes given a predator entity which can stimulate herding behavior during the 'fog of war' among disparate traders/trader-bots.
re: HFT opportunistic liquidity - good points as well. The success of HFT funds is like walking down the strip in Vegas and seeing the incredible buildings and lights whose empire has been built on the gaming industry - and then thinking that you have a fair change of winning money at any given game. You cannot simply because of the vast wealth accumulated by the house. If it was anywhere near a 50-50 proposition the law of large numbers would kick in and you would find yourself in something looking more like Primm.
Given the chance to work for Goldman Sachs, TD, you know you and anyone else would jump at the chance to work there... is there another iBank/hedge fund/conspiratorial super-corporation out there who provides the kind of job security GS does? I think not.... while I agree on principle that what they do is wrong in terms of their domination of program trading and whatnot, if given the opportunity to work there I would take it. And honestly you'd be a fool to turn it down!
actually; that would be like taking the role as emperor ( or one of his generals ) while Visigoths and Ostrogoths keep riding trough Milan slaughtering every roman general.
Somehow we have entered another time, another dimension. Rod Serling is in the room under the name of VS18. VS18 is clearly under the influence of money and dreams of job security. Last time I checked, that was not in the manifesto here...
Heh, not at all just making the point that anyone who even remotely cares a little bit about making lots of money would want to work with GS. I mean, how can you go wrong! Only two days where they actually LOST money trading! Where can ya find a track record like that anywhere man!
I defer to Chris Martenson on that one:
http://www.chrismartenson.com/blog/goldman-sachs-incredible-trading-returns-are-literally-unbelievable/23806
If ye love wealth better than liberty, the tranquility of servitude better than the animating contest of freedom, go home from us in peace.
We ask not your counsel, or your arms. Crouch down and lick the hands that feed you. May your chains set lightly upon you, and may posterity forget that you were our countrymen.
Sam Adams
Money can buy just about anything, but it won't buy you a good reputation or strong character.
Thanks for posting that. I could not have found a more appropriate quote.
funds already lost in playing the hand delt is blinding their ability to see that they are holding a loosing hand and no amount.
good articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions
Check out Roubini's 8/23 on how a commentator's political blind spots can turn him into the system's little lap dog. He talks about government intervention "crowding out private investment." This man has taken a career-induced flight from reality. He always had, how shall we say, "political doctrine issues." The result? He can't admit the facts anymore.
Look at this idiot. His own blind spots--his own addiction to a corrupt system--have tied him to the system's mast. He HAS to say there is a recovery, even though the market is clearly and in every way tracking that of the 1929 depression. He HAS to argue for private investment even in an oligopoly which has now gone in purely for theft. In short, he has climbed into bed with Lakshman Achuthan of ECRI. Both are trapped in their failed models. Both their failed models are based on their failed political ideas. Whoops! Watch out for that.
Hopefully, ZH will go back, take stock of its political agenda, and not marginalize itself as the system's clown, which is what Roubini has done.
ZH, stop fiddling around with algorithms.
OK, so here we go again with complaints about the "expense seems to always come out of the institution's pocket", and their job is "to create a safe environment for the institutions".
Isn't that just what we should expect from the "largest buy-side only dark pool"?
These people, and many others, simply have not accepted that 'investing' is simply speculation with a longer time frame. They are either unable or unwilling to adapt to these changed market conditions.
Let me emphasize: the markets are ONLY about speculation. There is no such thing as 'investing' in the public markets. There is ONLY speculation, on many different time frames.
If people want to 'invest', then they can take their money to private equity, or simply start and fund their own private businesses. There are no systemic or societal barriers to 'investing'. It's just going take a bit more work now.
People who rant about those 'evil speculators' always have a hidden agenda. They want the markets to operate only to their benefit.
Of course, we all want a fair market. So that means eliminating flash orders and probably eliminating co-location, etc.
But HFT itself should be democratized so that everyone, down to the smallest of account holders, can participate. That means lowering commissions to near zero or equal to zero, and removing all other barriers to entry.
There are some brokers out there that are slowly moving toward that goal (TOS for example).
The barrier to entry in HFT is not as high as some people seem to believe. Outside of having capital to commit to the strategy, $1mm (maybe even less) could easily get you up and running. Now, for the individual trader/investor thats a lot of money. But Formula 1 racing is pretty expensive too. Is it also unfair that everyone cannot afford to fund their own F-1 team? Some trading strategies are expensive to implement, just like there are barriers to entry in many other money making endeavors. Its not unfair, its just life.
Yes, life is unfair.
Here's another analogy: Life is unfair for many of the same reasons that the 'Efficient Markets Hypothesis' (EMH) is demonstratively false.
Opportunities in both life and finance are not uniformly distributed.
That invites arbitrage. In life, the rich exploit the poor. In markets, those with better information exploit those with less.
But that's really what this is all about isn't it? We are attempting to correct an imbalance.
Someone supposedly in the know told me TOS sells their order flow to Citadel. Citadel is one of the HFT heavyweights and they get to record the interest generated by your retail order and then decide whether or not to fill you at your price before routing. If they choose to fill you they now know a bit more about the weak hand position of aggregate TOS retailers. You're happy you got filled at the price you wanted. They are happy to know the average position price of many small players as they now have an indicator of sentiment, momentum and the point of most pain. In the absense of actual fundamental cashflow valuations, information about position concentration, levels and margins is a great foundation for extracting money from many small capitulators while having an idea of how much interest and support lies below or above your own traders' positions. Information asymmetry reduces risk.
BTW, completely agree with you on equity markets as only speculating and PE/VC/own biz as real investment. So maybe this is more about educating people that their weekly 401k autodeposits into market funds are not a savings account but a speculative gamble which converts their real world hard work into equity-points which may or may not be redeemable near their original value at the needed date. In the meantime the finance industry is converting their long term investment points into short term cash and spending it on real world shit.
RE: TOS selling order flow.
That's interesting, but on reflection, maybe not that surprising.
It would be better if that kind of information was publicly accessible, like Oanda does with its order and position book, and like FXCM does with it's SSI.
However, I think that kind of information selling is probably closer to the 'benign' end of the 'broker behavior' scale.
It seems like an anti-trust issue especially if Goldman has a dark pool and they account for a significant amount of order execution. All dark pools should be linked in a black hole and forced to trade with each other.
I think that shift came around 1984. Still, nice somebody else caught it.
Private equity?? Dead.
Real estate?? Dead.
Venture capital?? Dead.
"Alternative Investments?" Dead
After seeing the most extraordinary market reversal of all time in 2008, nobody, I mean nobody, is going to invest their fund's assets into anything substantial that cannot be immediately sold with a mouse click.
Liquidity and outsized trading volumes are only going to increase, as more and more "sophisticated" portfolio managers throw Monte Carlo into trash can, and entire portfolios will be gunned into SPY, QQQQ, TLT, etc. or will remain safely parked in cash.
In fact many big money managers are probably closing out ALL positions at the end of each day, just to be on the safe side.
The next day, they either stay in cash or pile back into bond or equity ETF's, which ever is running that day.
Only to close out the trade again by the market's close.
A half percent here, a quarter percent there, if you are lucky, 1.5% in a single day. Do that 100 trading days a year, then you are talking about "making your year" while taking practically zero overnight risk.
Good point
I honestly think it is too late for such requets. I think the efforts of all those blog post should concetrate on educating people as to the dangers of the capital market,rather than on effort to correct the misdeeds. It is too late for that. It is much better that people understand that there is no more investing,there is gambling. And once most understand that fact,then it is entirely up to them to participate,and they cannot come back later and cry foul.
But what do you invest in then?
> the market has shifted from one rewarding fundamental (and
> technical) analysis and a long-term vision of equity
> appreciation, to one which benefit only and exclusively
> short-term (intraday) speculation
Really?
> Is it any wonder why the bulk of funds end each day in a
> 100% cash position
You're just making this stuff up.
Literally, a positive future for Americans depends on stopping this spending today.
.
good articles; good articles 4 slow news day ..http://www..
hat tip: finance news & finance opinions
WHO WAS SELLING AT 666 AND WHO WAS BUYING AT 1078...WHY WOULD ANYONE BUY LITTLE PIECES OF PAPER THAT USUALLY PAY NOTHING TO THE HOLDERS AND CAN BE WHIPPED AROUND BY PEOPLE WHO KNOW NOTHING ABOUT WHAT THOSE LITTLE PIECES OF PAPER ARE SUPPOSED TO REPRESENT....ITS JUST STUPID-ESPECIALLY IN LIGHT OF THE FACT THAT COMPANIES ARE PRONE TO ISSUE MORE LITTLE PIECES OF PAPER TO FUND "COMPENSATION" ITS INSANE--LET COMPANIES FUND THEMSELVES OUT OF CASH FLOWS AND STOP INVESMENT BANKS PIMPING CRAP ON THE PUBLIC ..THE REASON WE HAD SUBPRIME & ENRON ETC IS WE HAVE SET UP A SYSTEM WHERE THE GATEKEEPERS ALL GET THEIR PALMS GREASED UNTIL BY THE TIME ITS OVER THE "SAVING" IS FUNDING THE NEXT CONDO BUILDING OR SOME OTHER STUPID SCHEME THAT PAID SOME JACKASS 10% TO RAISE THE MONEY...AND IF YOU DON T BELIEVE PAYING SOMEONE 10% WILL GET MONEY FOR ANYTHING..SEE BERNIE MADOFF AND HIS FUND OF FUND CRIMINALS