High Frequency Trading: Focus on ‘Troll Under Bridge’

SMITH BRAIN TRUST -- High-frequency traders provide a useful service but rig the system when they extract tolls from investors, a professor from the University of Maryland's Robert H. Smith School of Business said this week during a financial regulation conference in Australia. "They are like a troll under a bridge who charges travelers something extra when they cross to the other side," Albert "Pete" Kyle, the Charles E. Smith Chair Professor of Finance at the Smith School, has said (see his earlier Maryland Public Television interview).

Debate about high-frequency trading heated up prior to the conference when a U.S. brokerage firm agreed to a record-high fine for allegations related to the practice. In that case, the Securities and Exchange Commission levied an $18 million penalty against Investment Technology Group on allegations that the Wall Street firm misused its “dark pool” clients’ confidential information to implement high-frequency trading strategies.

High-frequency trading, which accounts for more than half of U.S. trading activities, is based on algorithms that analyze multiple markets and trading securities in microseconds. Michael Lewis argues in his 2014 book, Flash Boys, that the technology rigs markets. Kyle says what’s rigged is the tax-effect on investors.

Though the going rate of one penny per share seems small for investors buying fewer than 100 shares at a time, the fees add up for the large institutional investors who dominate the markets. During the Centre for International Finance and Regulation conference Aug. 11-12, 2015, in Sydney, Kyle said the "most logical" solution for markets involves the random processing of orders, rather than options such as a minimum resting time or batch auctions. Kyle also said high-frequency trading technology is becoming more like a commodity.

Just prior to the Australian gathering, a U.S. official lamented the technology's diminishing returns. "The constant pursuit to save one more millisecond not only consumes resources potentially better invested elsewhere, but increases the pressure on the plumbing of the system to handle ever-increasing speeds and messaging traffic," said Antonio Weiss, counselor to the U.S. Treasury secretary.

Kyle, though, said the technology "arms race" is almost over. He anticipates fund management firms to adopt the technology toward reducing their broader equity market transaction costs. Read more in the Brisbane Times...

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