Mark Cuban on High Frequency Trading

To the person who approached me about High Frequency Trading: I am not exactly an expert on this subject, although I have read a quite a bit about it.

One article I just read made a lot of sense to me, it is written by Mark Cuban, one of the "sharks" of the Shark Tank.

"The Idiots Guide to High Frequency Trading"

"1.  Electronic trading is part of HFT, but not all electronic trading is high frequency trading.
Trading equities and other financial instruments has been around for a long time.  it is Electronic Trading that has lead to far smaller spreads and lower actual trading costs from your broker.  Very often HFT companies take credit for reducing spreads. They did not. Electronic trading did.
We all trade electronically now. It’s no big deal.

2. Speed is not a problem
People like to look at the speed of trading as the problem. It is not. We have had a need for speed since the first stock quotes were communicated cross country via telegraph. The search for speed has been never ending. While I don't think co location and sub second trading adds value to the market, it does NOT create problems for the market.

3. There has always been a delta in speed of trading.
From the days of the aforementioned telegraph to sub millisecond trading not everyone has traded at the same speed.  You may trade stocks on a 100mbs broadband connection that is faster than your neighbours dial up connection. That delta in speed gives you faster information to news, information, research, getting quotes and getting your trades to your broker faster.
The same applies to brokers, banks and HFT. They compete to get the fastest possible speed. Again the speed is not a problem.

4. So what has changed ? What is the problem
What has changed is this. In the past people used their speed advantages to trade their own portfolios. They knew they had an advantage with faster information or placing of trades and they used it to buy and own stocks. If only for hours. That is acceptable. The market is very Darwinian. If you were able to figure out how to leverage the speed to buy and sell stocks that you took ownership of , more power to you. If you day traded  in 1999 because you could see movement in stocks faster than the guy on dial up, and you made money. More power to you.

What changed is that the exchanges both delivered information faster to those who paid for the right AND ALSO gave them the ability via order types where the faster traders were guaranteed the right to jump in front of all those who were slower (Traders feel free to challenge me on this) . Not only that, they were able to use algorithms to see activity and/or directly see quotes from all those who were even milliseconds slower.

With these changes the fastest players were now able to make money simply because they were the fastest traders.  They didn’t care what they traded. They realized they could make money on what is called Latency Arbitrage.  You make money by being the fastest and taking advantage of slower traders.

It didn’t matter what exchanges the trades were on, or if they were across exchanges. If they were faster and were able to see or anticipate the slower trades they could profit from it.
This is where the problems start.

If you have the fastest access to information and the exchanges have given you incentives to jump in front of those users and make trades by paying you for any volume you create (maker/taker), then you can use that combination to make trades that you are pretty much GUARANTEED TO MAKE A PROFIT on.

So basically, the fastest players, who have spent billions of dollars in aggregate to get the fastest possible access are using that speed to jump to the front of the trading line. They get to see , either directly or algorithmically the trades that are coming in to the market."


Please read the remaining article at the link above for more. Also the comments provide quite a few good pointers.

I would be very interested to know the exact situation both regarding Bursa and SGX. Are they allowing HFT? If so, what percentage of the trades are executed by them? To what extend can HFT players get an advantage?

What is the business of an exchange?

Outspoken billionaire Marc Cuban is an US investor and participating in one of my favourite TV series "Shark Tank", where founders pitch their ideas to a panel of judges who put their money where their mouth is. Parts of episodes are easily available on YouTube. Cuban can come across as rather arrogant, but he also did quite a few very fair deals in the TV show.

Marc Cuban spoke out against High Frequency Traders (HFT) in a recent interview in The Wall Street Journal. Some snippets from this article:

Concerns about the impact of rapid-fire trading on the markets has ramped up of late, especially after technical glitches at Nasdaq fouled up Facebook’s trading debut. Last Wednesday, market honchos such as NYSE Euronext Chief Executive Duncan Niederauer were grilled by lawmakers in a hearing about the current state of the market. One clear message from the hearing was that a proliferation of computer trading and opaque markets has hurt investor confidence.

Mark Cuban:

"That got me looking further into issue of high-frequency traders. They are the ultimate hackers. They’re running software programs that have one goal, and that’s to exploit the trading systems as early and often as possible. As someone who wrote software for eight years and who keeps up very closely with the technology world, that scared the hell out of me. The only certainty in the software world is that there is no such thing as bug-free software. When software programs are trying to outsmart other software programs and hack the world’s trading platforms, that is a recipe for disaster."

"Public companies need to figure out what business the exchanges are in. Is the market supposed to be a platform for companies to raise money for growth and to create liquidity and opportunity for shareholders as it has been in the past? Or is the stock market a laissez-faire platform that evolves however it evolves? The missing link in all the discussions is: What is the purpose of the stock market?"

Cuban did write about this last issue in the past on his own blog:

"However we need to do it, we need to get the smart money on Wall Street back to thinking about ways to use their capital to help start and grow companies. That is what will create jobs. That is where we will find the next big thing that will accelerate the world economy.  It won’t come from traders trying to hack the financial system for a few pennies per trade.

Wall Street as a whole needs to be in the business of creating capital for companies and selling shares to investors who believe they are shareholders.  The Government needs to create incentives for this business and extract compensation from the traders/hackers for the systemic failure level of risk they introduce."

The number of listed companies in the US did shrink markedly in the last decade. Is it possible that all the financial engineering (derivatives, hedge funds, HFT, etc) has not added any value at all, in the contrary?

This is all very relevant also for Bursa Malaysia. Who do exchanges actually serve, who do they want to attract? Traders only interested in making short term profits, or genuine investors? And what kind of companies will they attract?