There was a time when people wanted the fastest networks so that they could trade at lightening speeds. They deployed the smartest formulas at trading venues where no one could know who was asking for that big block of stocks on the other end of the deal. It was a wild time and people made a lot of money along with some very unwise decisions.
Wall Street seems to be acting out the lyrics to a Don Henley song. The party’s over, the hangover is raging and no one really knows what happened the night before.
[The dark pools' choice: Go into the light ot down the drain.]
Last week we looked at the terrible beating that dark pools were getting from pols, regulators like the SEC and FINRA, and from the CEOs of the major US exchanges. Someone is about to turn on the lights on these mysterious unlit exchanges. We’ve also examined algorithms that went rogue and behaved in ways that no one foresaw when they jotted them down on the whiteboard.
And now high-frequency trading is taking a long look at itself in the mirror. In the cold light of day, traders are rethinking their once favorite way to execute deals in the blink of an eye.
For the first time since its inception, high-frequency trading, the bogey machine of the markets, is in retreat. According to estimates from Rosenblatt Securities, as much as two-thirds of all stock trades in the U.S. from 2008 to 2011 were executed by high-frequency firms; today it’s about half. In 2009, high-frequency traders moved about 3.25 billion shares a day. In 2012, it was 1.6 billion a day. Speed traders aren’t just trading fewer shares, they’re making less money on each trade. Average profits have fallen from about a tenth of a penny per share to a twentieth of a penny.
According to Rosenblatt, in 2009 the entire HFT industry made around $5 billion trading stocks. Last year it made closer to $1 billion. By comparison, JPMorgan Chase earned more than six times that in the first quarter of this year.
As the founder of HFT firm Tower Research Capital Mark Gorton puts it, "The easy money’s gone. We’re doing more things better than ever before and making less money doing it."
[What's causing the recent wave of exchange outages?]
What happened? It depends on whom you ask. Hedge funds had a rough year last year and several funds have closed up due to lack of interest. Others are more famous for their arrests and convictions of insider trading than their client returns. And while the stock markets have been on a tear in the US this spring, so-called 'mom and pop' investors are staying out. Why? A lack of liquidity and a feeling that the recession may be over but the good times have not arrived. Critics of HFT say the smaller investors are out because they cannot compete against the HFT crowd even though most brokers offer their own flavors of high speed trade execution.
Politicians in the US and other leading markets are proposing limits to the unchecked speed of HFT. Bloomberg reports that Iowa Senator Tom Harkin and Oregon Representative Peter DeFazio want a .03 percent tax on nearly every trade in nearly every market in the US. Even calls for a nickel fee on every HFT trade or cancelled order, which is a hallmark of HFT, are gaining momentum. If enacted, traders will have to ask themselves if they really needed to trade that fast.
While reports of HFT's demise are premature, traders and supporters are clearly sobering up. It will be interesting to see if behavior will change among traders or if this is yet another promise to turn over a new leaf after some destructive decisions.