Stoking the Information Engine, Insiders and HFT

Information, it’s the fuel that stokes the decision making engine in industry and government. The data trail behind the information flow often comes from a multiplicity of sources. Each individual data element is used like a piece of a puzzle to form a picture, a glimpse into a crystal ball of future events, naturally with some amount of probabilistic risk implied.  The better the information the lower the risk.  Two factors are key in the trading world, 1) getting and deciphering the information, 2) acting  upon it before your competitors. These are the same two factors I’ve written about in the past – data and performance, and they are vital to the trade-decision making process.

But sometimes the trail leads down the wrong path.  Sources of non-public information from a network of well-connected industry specialists known as “expert-networks” have been under the watchful eye of federal investigators. The story of insider-trading exploded like a mushroom cloud sending a shock wave through the financial industry. “Inside information is a form of financial steroid …” as Manhattan U.S. attorney Preet Bharara recently stated. The SEC has been carefully watching and has shifted focus, from a trade-by-trade transaction investigation to one seemingly employed to snare a spy ring.   The typical surveillance software a firm might deploy to protect against rogue traders is of no value here. This type of insider trading is not your typical wash trading collusion between traders or the other handful of known techniques that surveillance systems can detect. This is more like government lobbyists and their network of connections to experts providing access to key information.  The difference of course is lobbyists and the information they provide to influence government officials is not considered illegal.

It looks like HFT is the next target of federal investigators.  One can only hope that a fair judgment be done.  There has already been much discussion on regulations for flash orders, stub quotes, minimum quote durations and a flurry of market making rulings.  Moving cautiously to enact those will remove the majority of the inequities in the high-frequency trading world. As Joseph Weber is his TABB article succinctly states, we should wield a scalpel not a meat axe in enacting HFT regulations.

Even for market making the debate weighs in favor of HFT,  this article squarely challenges the old specialist model. A closed-loop non-public club:

“[market making] was a tight Old Boys club – you couldn’t become a specialist just because you wanted to and had the ability to – you had to crack the club. It was positively non-public in terms of opportunity. Today, however, the process has become democratized – anyone who has the ability and the means can compete in the world of high frequency trading…

This reminds me of the 1980’s when IBM had a complete lock on the computer industry (just before and for a short while after the advent of the personal computer). They owned the market and its rate of technological change. The old adage “if IBM couldn’t do it nobody could” rang true. Sure there was the BUNCH but realistically their insignificant share of the market never cracked IBM’s dominate hold. It took a few decades and a little machine (of IBM’s own making) to wrestle control of the industry away from IBM and democratize something we now take for granted globally – the ubiquitous personal computer.

There are those that argue that HFT presents an unfair advantage. Certainly, some have abused the privilege of high-speed, low-latency, co-loc, algo trading and have in fact forced the hand of federal regulators. However, it’s a Luddite’s view to think we can return to the presumed good-old-days. Much has been written recently about the insider-trading investigations and they’re intended goal to  “level the playing field“. You could argue that high frequency trading has already done that.

Once again thanks for reading.

For anoccasional opinion or commentary on technology in Capital Markets you can follow me on  twitter, here.

About Louis Lovas

Director of Solutions, OneMarketData, with over 20 years of experience in developing cutting edge solutions and a leading voice in technology and trends in the Capital Markets industry.
This entry was posted in Algorithmic Trading, Analytics, Complex Event Processing, Equities, Foreign Exchange, Futures and Options, Tick database. Bookmark the permalink.

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