Joe Saluzzi: HFT Parasites Are Killing The Market Host

Tyler Durden's picture

Submitted by Chris Martenson of Peak Prosperity

Joe Saluzzi: HFT Parasites Are Killing The Market Host

Joe Saluzzi, expert on algorithmic trading -- also known as high-frequency trading, or HFT -- returns as a guest this week to explain how the players behind this machine-driven process act as parasites that are destroying our financial markets (and, increasingly, even themselves).

Since Joe first spoke with us last year, HFT firms have only increased in size and share of market activity. Here are some staggering statistics on how influential they have become:

  • HTFs make up between 50-70% of the volume seen across market exchanges today
  • 2% of the traders on many exchanges (HFTs, specifically) represent 80% of the volume
  • a single large HFT firm (referred to as a Direct Market Maker) can account for 10%+ of a market's volume on a given day
  • Large HFT firms make between $8 to $21 billion a year
  • HFT trades occur in milliseconds (i.e. a small fraction of the time it takes your eye to blink)

With such scale, speed and profitability, HFTs have turned the market away from being an efficient price-setting mechanism and perverted it into a casino where the clientele (i.e. human investors) gets fleeced.

And our regulators are so outmatched by the scope, complexity and funding of these titanic HFT players that at moment, there are pretty much zero consequences for bad actors.

Interestingly, these HFT parasites, which live by generating fractions of pennies in millisecond-timed trades, may be sowing the seeds of their own demise through their blind gluttony and hyper-competitiveness. As their quest for incremental advantage begins to bump up against the limits of physics (such as the speed of light), the marginal cost of the next increment of advantage increases exponentially. Profitability is being squeezed out and will disappear entirely some day.

Sounds good to the rest of us investors, right? Not so fast. A key question to ask should these parasites experience a self-induced mass-extinction effect:

What will happen to asset prices when all that volume suddenly disappears?

HFT's Bloodsucking Role In the Financial Markets

There is a host-parasite relationship. The host is the traditional order or the retail or institutional order. They will always lose. There is no doubt about it. The parasites are circling around that host all day long trying to find where they are going to take advantage of them – whether it is a VWAP order (Volume-Weighted Average Price) or something like that. If there are no hosts or the hosts are starting to decrease – because they are based on the mutual fund outflows that we talked about before – the parasites find it hard to make money. There is no more to feed off of. So they start to feed off of each other, which means that their margins by definition are going to have to start shrinking until it becomes unprofitable. And it will become unprofitable when all of a sudden they have to invest hundreds of millions of dollars to gain an extra microsecond, yet they are not getting their returns back.


o the real fear that we have is that when it becomes an unprofitable opportunity or venture for them, what will they do? Will they walk away? Who will be left holding the bag? Where did all that “liquidity” go? Who is left now? Hopefully what will happen was the market will find its own solution at that point. But you would have some scary days, I can bet, between now and then.

The Bastardization of "Investing"

If you are an investor and you want to diversify -- which everybody should be doing, right? -- you want to pick different asset classes. You want to get things that are inversely correlated because that is how you can prevent yourself from taking a large loss, especially if you are a conservative investor.


There was actually a report – I think it was a couple of months ago and it was produced by the U.N. --  they studied the correlation between oil and stocks. And they found it at record levels over the last five years. It just shot up off the charts where oil would normally be a negative correlation with stocks. And they were scratching their heads. And one of the things they pointed to was the correlation effect of the high frequency traders trading multiple asset classes.


So this has been documented now. It is not just us kind of guessing, saying, “Well, I bet it was the HFT’s correlating asset classes.” Everything trades together. That does not make for a healthy market. That does not make me feel comfortable that I can hedge my position right now unless I was just trading around a zero position all day, like most of these guys do in the high frequency trading world.


So what do you do as an investor? How do you diversify yourself? It is very, very troubling and at this point there really is not an answer to it.

The Impotence of Our Regulators

When you are dealing with this type of computing power and this heavy amount of quote traffic as well as trade traffic, the quote traffic is enormous. Every time an exchange tries to update their capacity, it immediately jumps up to the capacity level. It is a constant amount of quotes, trades, and cancellations. They do not have the systems available to track this type of behavior.


So you have got one of two options if you are a regulator. Either, a) get up to speed quickly so that you can track this behavior so the investing public could feel confident again. Or, b) you have to start limiting this type of behavior. There is no other option. You cannot allow this to continue to go on. And by limiting it, something that we would suggest is maybe a real cancellation fee, not the ones that have kind of been suggested. Maybe a minimum order timelife. If I said to you, “Hey, we want a 50 millisecond minimum order timelife, would that be a problem?” And I would think it would not be a problem. Because, guess what? I just blink my eyes and it took me 200 milliseconds to do that. So 50 milliseconds really should be that big of an issue. And there have actually been reports – studies by academics that have said, “Any order less than 50 milliseconds really does not contribute to any liquidity.” So do not give me that you are going to be hurting liquidity.


So the bottom line is the regulators are overmatched and they need to do something now. And they have really one of two options. And the option of getting up to speed probably is not in their budget right now.

Click the play button below to listen to Chris' interview with Joe Saluzzi (47m:53s):

Transcript available here.

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sunaJ's picture

Burn it down.  Let God sort it out.

ACP's picture

Actually, that's a good idea. Makes me want to have an HFT platform in order to kill the host faster.

There's one thing the exchanges must the great Bugs Bunny once said:


CrimsonAvenger's picture

I think there's a parallel here with what Einstein said about war - he didn't know what WWIII would be fought with, but he was confident WWIV would be fought with sticks and rocks.

Once HFTs blow the market sky-high - and they will - any coordinated financial market that replaces it is going to be a very simple affair.

TraderTimm's picture

In the futures markets there are a lot of traders that wish the electronic scourge would go away, so we could go back to good old open outcry. A cry from those that don't adapt, perhaps, but I wouldn't mind at least seeing realistic controls on a market that is chock-full of a billion flying razor blades of HFT.

50milliseconds? Bring it on, seriously. Its either that or we get to witness a cascade failure that would put Valve's "Halflife" to shame.


Mentaliusanything's picture

If you want it gone for good ......then put a very small charge on for each and every bid & offer (even if for a millisecond)

Let them pay to play. It won't hurt the day traders and the normal bidders but it will curtail the algo's ability to steal a penny

HD's picture

The universe produces astounding amounts of gold every second through stellar nucleosynthesis. Yet, stars produce exactly zero fiat.

God has already sorted it out...

Marginal Call's picture

Clearly, the galaxy needs more dollars.  A huge opportunity to do God's work. 

thomas pain's picture

Who needs a God when you got Satan

Clint Liquor's picture

So what do you do as an investor? How do you diversify yourself?

Diversify into Gold, Silver, Lead and high speed Lead dispensers.

Fidel Sarcastro's picture

"HFT trades occur in milliseconds (i.e. a small fraction of the time it takes your eye to blink)"

Sorry, more like MICROseconds.  A friend of mine had his best clicked speed at just 4 MICROseconds.  He's on the edge of NANOseconds.

veyron's picture

Round-trip time 30 microseconds

Catflappo's picture

I can react to a price change and click my mouse all within 2.7 seconds (my best).   Is that any good?

TrainWreck1's picture

I can execute my biological prime directive in 2.7 seconds.

Oddly, women do not appreciate this efficiency, so I now deny them my essence.

dogbreath's picture

they don't know what they are missing

Id fight Gandhi's picture

That's where why you need to diversify. Add more women to the queue.

Dr. Kenneth Noisewater's picture

Coloing with, say, BATS or ARCA on a 10G ethernet or 40G iband will get you microsecond access, but you'd need to be on the same physical hardware to get nanosecond order filling.  Or, you just get a bunch of HFTs together to create their own shared dark pool on a huge honkin server with a few terabytes of RAM, and you'll have nanosecond latency.

TrainWreck1's picture

Maybe the insiders have direct connections, bypassing the Interweb? Or even the HFT programs resident on the main system, wherever that is? The latter would be a neat trick - you could never beat something running on the inside, no matter how fast your connection.

Naw, the SEC would never permit such shenanigans...


Catflappo's picture

I have got a Commodore 64 wired up to a cassette drive and when combined with my mouse-click-reaction-time (see above) I am now able to hit bids before they even arrive in the market.

Only by a few seconds, but I think its statistically (not to mention chronologically) significant.

Need to do more work on it though.


Al Gorerhythm's picture

There's no room for Ma and Pa Daytrader in this room. Flash crashes will decimate an account, limit orders ignored and positions over-run. According to some experts, these flash crashes happen just by circumstance or in a vacuum. The longs are the ones standing aside when this happens, is the reasoning behind their defence of the system. Poor old ma and pa are watching Level 2 screens, expecting their orders to be filled according to the information they are receiving, ignorant of the fact that they are being overpowered by front-running market makers who set the algorerhythms to do just that.

Say goodbye to your margin account and to your pension accounts and holdings, as these guys front run you and churn your account/holdings (shares, bonds, financial deivitives) between one another to skim a profit or fee. 

Move along now ma and pa. Go beg on some other street corner. This one's mine.

LeisureSmith's picture

Pure unadulterated fraud juice.

cbaba's picture

Confessions, too little too late... best thing is to Reset the whole system.

chump666's picture

The HFTs need to be shut down immediately, Europe last session was embarrassing.  We are due for another huge HFT panic wipe-out.  Looking like an oil spike ala Iran tensions may do it.

Ned Zeppelin's picture

Close your  401k, or at least opt of equities. I think it much harder to manipulate bonds. 

Get your act together and stay out of the casino. 


Al Gorerhythm's picture

Too many back room deals in bonds. It may be harder but eventually the "job" will get done. Just ask any holder of Greek bonds on their last cap in hand approach to the ISDA for a fair hearing on their CDSs tied to their bonds. It's all a Ponzi based on another layer of fraud. The Goldman Mafia has a new game to play. GET OUT.!! PERIOD.


I up ticked you until I thought about it a bit but have my (ahem)...... reservations.

dcb's picture

if you believe what you say try trading tbt/ tlt

tbt went from it's weekly high friday, to the weekly low today (lower weekly low.

there used to be some point in having bonds or shorting them, and that wasn't too long ago, now the bond owners are just making sure they don't take losses on their portfolio, no difference, besides there have been many articles of hft spreading to bonds.

this may hav e been the case before, but not now.

NeedleDickTheBugFucker's picture

And here I thought (fraction of a) penny-shaving was illegal.

jackinrichmond's picture

this is so easy to fix..

if i have to pay to trade. so should the HFT's.

i'm not talking about a 'reduced' rate. i'm talking $29 per trade.  

if the powers-to-be don't level the playing field, the retail traders will never come back.


crime and corruption have ruined the markets.  

i think the regulators are to blame.  playing politics is for politicians not regulators.

..but hey.. if some fat-cat suit offers you a better job with a big raise when you leave public service...

i guess the regulators are just taking care of number one. to hell with their oath.  money is more important than their honor and social responsibility.


i want dr.bill black on this.  at least he has some integrity and the balls to follow through.


adr's picture

I want to trade in a market.

There is no market only Zool.

I'm thinking that would be the voice of the market if it had one. Maybe you could close the gateway to the HFT dimension of hell if you crosed the network cables, send Goldman the information meant for JP Morgan.

Just have to watch out for the Print Fest Fiat Ben.

rehypothecator's picture

Since Congress is all about penalties taxes these days, it would be a simple matter to extend the short-term captial gains rates to, "those assets held less than one second" and "those assets held less than 200 microseconds.  With, say, tax rates of 30% or 50% or 99%.  But, they won't because government is basically criminal, the banksters being part of the gang.  

q99x2's picture

Extinction Level Event. Dead market. Broken. Now what?


catch edge ghost's picture

It will take a few more years I think, but once the infrastructure is robust and the easy profits (hush money) have been taken, regulators and the planners that hire them are going to yank away the low-hanging fruit from most of these parasites. Not from all of them of course. There's always gonna be a need for 'leadership' and 'trust', like we have with JPM and SNAP or with Primary Dealers and US Toiletry Notes.

Following that will come Social Security reform. A new mandatory savings regime for the US is in the works. Not so new really, just a more direct route for withheld wages to enter the capital wonderland. It cannot operate as intended without the systems HFT is creating today. Without absolute controls to regulate price discovery and to manipulate its mechanisms, mandatory ROTH IRA's For Everyone isn't going to last for long.

The abuses and machinations observed today are merely Research & Development in the eyes of our Great Leaders. HFT is just another tool in the box of hyper-controlled inflation.

yogibear's picture

Let the vampire trading bots suck other trading bots accounts. Maybe a few hundred derivative chains can blow up in the process.

nahshal's picture

good comment... vampire trading bots not vild ...

chains are blow up in the all process..

jogos online

GoinFawr's picture

Svend and Peder saw the forest for the trees, spoofed an algo or three, and have since been cleared of all wrongdoing. If you won't join 'em, beat 'em.

blueskies123's picture

The market used to be a place where even small retail investors could make a few bucks on trades, but now the market gets pumped up on bad news with all the quantitative easing free money sloshing around, and investors being forced to buy dividend paying equities because they can't earn anything on savings due to the Fed slashing interest rates, and my gut tells me that if you have limit orders, those limit orders are relayed to these big players who prey on the little investor's limit orders to force them to have losses because their positions are known.

The market is a really fuc--ed place. The fed/CB's pump up futures overnight or sometimes will do a psy-ops where futures overnight are negative, really negative, but then when the market opens, the markets magically get turned from red to green.

Yes of course I've lost money but I have learned finally thanks to posts like this and Trimtabs Charles Biderman (thank you Mr. Biderman) that the m arkets really are rigged and why.

HFT just adds insult to injury and HFT traders are there to game and beat any retail investors to any profits.

Lebensphilosoph's picture

Markets have never been 'efficient'.

Tortuga's picture


RICO all banksters, their ho politicians and IMPEACH the racist, Eric Holder.

SantaCruz's picture

A fast easy solution would be to introduce a 1-second rule for all orders entered into the electronic marketplace.  All orders must remain in the system as open for at least 1 second.  An order cannot be entered and cancelled/changed inside of 1 second.  This will/may eliminate 99% of these issues and will go a long way to leveling the playing field.