Joe Saluzzi, co-founder of Themis Trading LLC, outspoken exchange expert, and author of the excellent exposé Broken Markets, returns to give us an update on the state of high frequence trading — otherwise known as HFT.
In the past, Saluzzi has been a vocal critic of the dominant and parasitic role HFT algorithims play in today's financial markets, siphoning off profits at the expense of the "dumb money" (i.e. retail investors) while undermining the integrity and stability of exchanges. Front running, spoofing, flash crashes — HFTs are the culprits behind them.
Saluzzi actually has some positive developments to note: namely that the obscene profits the HFTs used to make (i.e., steal) are moderating as the arms race in the industry has escalated and the players are increasingly competing with each other. Also, the SEC appears to be moving much faster now towards putting some material constraints in place.
But the unfair advantages that HFTs enjoy, as well as their threat to market stability, are still very real. If we don't continue to fight to bring them under control, we risk a vicious downdraft during the next big market crisis should the algos instantly exit in a panic:
If the HFT algos get spooked and stop trading, then you got a major problem.
In times like this when there's no storm out there, it's time to fix the house now to make sure that when the storm comes the house doesn't get knocked down. So how do you fix the house? By getting rid of the conflicts of interest, maybe adding more obligations for market makers, looking at those off-exchange venues which are considered 'dark pools' and learning what's going on there, looking at all different types of the issues that continue to haunt us — most of which don't become visible until they don’t pop up at the end.
Can you force a market maker to stand there and buy stock when the stock market is coming down? No. You can't force them to do that. And that's the way it is.
You can't assume that there's going to be liquidity today at this minute because there was a liquidity yesterday. It doesn’t make any sense. The market makers will disappear. So is there enough natural liquidity? And that's really the issue. Natural liquidity is real buyers and sellers, institutions and retail. And unfortunately, natural liquidity is still much, much smaller in the market than the 'artificial' liquidity created by HFTs.
So I still think you focus on fixing the structural issues. You'll have better odds, but will you prevent another flash crash? No.
There was a famous story back in the 2010 crash. They quoted one HFT trader as saying, "I saw it coming. I saw that it was happening, and I went to my keyboard, and I typed the letters "HFT STOP", and I hit enter. And that basically took me out of every market." So basically, he had a ripcord. He pulled the ripcord, and it took him out because he didn't know where the risk was. He didn't know what markets were doing what, and he wanted no part of it. So what happens if everybody types in HFT STOP at the same time? You'll get a major vacuum in liquidity again. You can't prevent it. You can't.
So yeah, when things next get hairy, I'd expect markets to get really choppy out there.
Joe also has some choice words for the crypotcurrency market, where he sees a lot of the worst risks he once saw during the early days of HFT:
I think that this market is just filled with fraud, filled with manipulation, filled with all sorts of abuses. And until you can somehow figure out a way to regulate it, no way – and I'm very strong on this opinion – no way should any crypto ETF be formed or approved by any regulator in the U.S. How are you going to create a derivative based on a crypto currency which is unregulated? It's a timebomb.
Click the play button below to listen to Chris' interview with Joe Saluzzi (48m:16s).