Charles Schwab: High Frequency Trading is a growing cancer

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Wow, even Chucky is now speaking out against the abuses by the High Frequency Trading (HFT) club. Maybe we can finally get some thoughtful changes from our useless securities crook protection agencies. Maybe even the Federal Reserve chief might even speak in a positive way about new regulation…which would be a nice change after a couple decades of protecting the crooks.
http://www.aboutschwab.com/press/issues/

High-frequency traders are gaming the system, reaping billions in the process and undermining investor confidence in the fairness of the markets. It’s a growing cancer and needs to be addressed. If confidence erodes further, the fuel of our free-enterprise system, capital formation, is at risk. We can’t allow that to happen. For sure, we still believe investing in equities is a primary path to long-term wealth creation, and we believe in the long-term structural integrity of the markets to deliver that over time for individual investors, which is all the more reason to be vigilant in removing anything that creates unfair advantage or undermines investor confidence.
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High-frequency trading isn’t providing more efficient, liquid markets; it is a technological arms race designed to pick the pockets of legitimate market participants. That flies in the face of our markets’ founding principles. Historically, regulation has sought to protect investors by giving their orders priority over professional orders. In racing to accommodate and attract high-frequency trading business to their markets, the exchanges have turned this principle on its head. Through special order types, enhanced data feeds and co-location, professionals are given special access and entitlements to jump ahead of investor orders. Last year, more than 95 percent of high-frequency trader orders were cancelled, suggesting something else besides trading is at the heart of the strategy. Some high-frequency traders have claimed to be profitable on over 99 percent of their trading days. Our understanding of statistics tells us this isn’t possible without some built in advantage. Instead of leveling the playing field, the exchanges have tilted it against investors.

 

[ksen]

I don't know how this is not considered insider trading.

 

[Rhea]

What can make a change to this?

 

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What can make a change to this?

There are many regulatory changes that are not all that complex that would reign these abuses in. However, our political leaders and our regulators have been defending the newer wild wild Wall-Street for a long time. So meaningful changes will probably be a hard sludge thru the DC circus…

I would rather let thoughtful financial professionals, that recognize there are serious problems, come up with improved regulations. However, here is another older article that sounds reasonable on a couple of points related to HFT; and the failure of the SEC to perform their job:
http://www.financialsense.com/contributors/karl-denninger/hft-still-dancing-around-the-issue

One of the most-important differences that these firms exploit is margin requirement differences. If you are sitting behind your terminal you are prohibited by your trading platform from entering an order you cannot clear and all orders you have open but un-executed count, because they might execute.

For example let's say you have $20,100 in equity in your account and the per-contract initial margin for a futures contract you wish to trade is $5,000. You cannot have more than four orders outstanding to open a position at any given time that stand independently of one another. That is, while your brokerage might well permit you to have an order to buy a contract at 1400 and short one at 1398 as a "OCO" order (one cancels others) and count that as one margin requirement what they do not permit is for you to enter an order to buy one contract at 1400 and another at 1402 and another at 1404 and count all those as one margin; your margin capacity is dinged for all three because it is entirely possible that all three orders will execute.

More to the point you cannot enter five orders; the brokerage systems will prohibit it, as you can't clear those trades even if you believe that if the market goes your way by the time you get to the 5th order your unrealized gains and thus your liquidation value will permit its entry. You must wait until that happens before you can enter that 5th order.
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It is broadly illegal to place into the market an order that one does not intend to execute. That is, you cannot place an order into the market intended to goad someone else into acting, or through any other device attempt to manipulate price except through a bona-fide offer to buy or sell the security in question. The key here is "bona-fide"; an order placed and then immediately canceled where the entity doing so is trying to present the appearance of an interest to execute where one does not exist is illegal.

Since the Securities and Exchange Act requires that all orders must be intended to execute there's a simply way to prevent this sort of nanosecond game, where any part of the strategy involves "flashing" an order that isn't really intended to execute and thus clear through the exchange: Force all orders to be valid for two full seconds or until executed.