Stop The Parasites

Well, we had another flash Crash yesterday, just like the one on May 6, 2010. The only difference is, this time the stocks in question went up instead of down.

In case you missed it, Washington Post’s stock went from $458 to $900 per share in the blink of an eye. All the orders at $900 were cancelled and the market authorities did the usual, “move along folks, nothing to see here,” bit.

The culprits in both incidents (May 6 and yesterday) were High Frequency Trading Programs (HFTPs).

The HFTP industry (and lobbying efforts), always defend their actions by stating that they provide liquidity or make sure the markets are efficient or other nonsensical arguments that fall apart the minute you spend more than 10 seconds thinking about them.

Rather that going over how this whole system works, today I thought it better to simply state the obvious which few people actually do when it comes to this topic.

HFTPs provide NO benefits to the markets. None.

In fact, they are a net drag on:

1. The market
2. Investor confidence
3. The US economy

Regarding #1, HFTPs are a net drag on the market because they cause it to become nothing more than an overleveraged correlation game. For most of 2009 this correlation was between the Dollar and the S&P 500 (-0.98 in fact). Now the correlation is between the Euro: Japanese Yen and the S&P 500. The market is literally following this currency pair tick for tick.

Stocks are NOT meant to be half of an “if A, then B” formula. They are meant to be an asset class that is used to generate wealth and real return, something which people put their money in, hoping that the economy and the company’s results are what drive price.

This brings us to point #2: HFTPs act as a net drag on investor confidence.

HFTPs front-run other REAL investors who actually bother performing analysis or making their own judgments. If an HFTP were a person, it would be the equivalent of a kid who simply steals other students’ answers before they turn in their tests. Is this person really an “A” student? Does he/she really deserve to be a top performer in the class?

The answer to both questions is a resounding “No.”

However, in the case of HFTP trading in the markets, the damage is even more severe because they’re not simply copying someone’s trades, they’re actually TAKING their money.

Remember, investing is a zero sum game. Someone is always on the other end of a trade. So the money HFTPs make (billions) is actually money they’re taking FROM other people. The fact that it’s cleverly dressed up in market-talk of liquidity and efficiency doesn’t take away the fact that other people’s cash GOES into HFTP bank accounts.

Now, that REAL investors have finally begun to catch on that the regulators permit this kind of front-running, they, like anybody who finds out someone else is stealing their ideas, have decided to stop participating in the market.

This is why volume remains a trickle (people proclaim that volume is actually higher today than five years ago, but 70% of market volume today is HFTPs). It’s also why people have begun to HATE the stock market.  They know it is manipulated and they know that it’s crooked. That’s why they’re not participating in it anymore.

And now for #3: HFTPs are a net drag on the US economy.

HFTPs are designed by mathematicians, statisticians, computer scientists, engineers and the like. These are all people who could be putting their intelligence and talents to work developing new products, new ideas, new technologies, and other items that could actually HELP the US economy get back on its feet.

Instead, they, like most people, are looking out for the own self-interests and have accepted high paying jobs at HFTP firms. After all, why make $50K doing research when you can make $5 million front-running other orders in the giant casino we call the stock market?

Scroll through any job posting for analysts/ traders and you’ll see the same thing:

Wanted: Math PhD/ Engineer/ Astrophysicist for Proprietary Trading/ Algorithmic trading team.

All those PhDs are leaving the US “brain trust” to get rich on Wall Street. In this fashion, HFTPs act as a brain drain on the US economy and result in more and more of our economic activity being related solely to financial speculation, not creating anything of actual economic value.

In plain terms, HFTPs provide NO benefit to the markets or US economy. Those are the facts. And the more time we spend ignoring them and doing something about it, the worse the damage will be.

May 6, 2010 will not be an isolated incident. There will be more May 6’s in the future. And they will be even larger and more damaging. The time to put an end to this is now.

Good Investing!

Graham Summers