Quote from propseeker:
in a market with no short term traders, you'd be paying spreads that are nowhere near a nickle.
True. Though, you are making a case for market makers, rather than HFT's.
Did any of you take debate class in hi school? Remember how it was important to agree upon term definitions at the beginning? Market making and HFT strategies have become like concentric circles in the stock world--making this discussion difficult.
In the stock world, the successful market making companies have started to use many HFT strategies out of necessity. In the options world there is still a very clear distiction between the two.
There is a difference between pure market making and HFT methodology, as per my definition of these terms. Though the same firm may do a bit of both.
The order information disseminated to some dark pool operators (which is what I would refer to as flash quotes) and some dark pool participants as well as order internalization (basically just a one market maker dark pool) gives a select group of well connected players huge, unfair advantages. RegNMS only covers the public exchanges. Therefore if a dark pool operator has internalization deals with retail brokers (like Citidel does with E-Trade), all they have to do is sub penny the public exchange prices to legally internalize these non-public orders. If Citidel/Getco/GS/Knight/IB chooses not to internalize the trade, they can still use the order info to make proprietary trading decisions before that order ever hits a public exchange. This company may be making markets on a public exchange, but they are basing their public markets off of non-public order flow information. Read the fine print when you sign up as a Sigma X customer, which states that GS may make trading decision off of your order if you don't believe me. If that isn't the defintion of front running, I don't know what is. This kills liquidity for all other participants who don't know the orders coming through the pipeline. All the while, the HFT company may adjust theoretical values due to non-public information. This sucks liquidity from everyone else, and hands it to the HFT company.
Similarly, in the options world, payment for order flow is a liquidity killer. If a company is a registered market maker, they must pay .65 per contract every time they trade with a customer counter-party. Since dark pools do not fall into the same regulation, HFT companies register as customers in the public exchanges. These companies send .5 cent wide markets into dark pools. If they get hit on a trade, they cover by routing the exact opposite trade via naked sponsored access brokers into a public exchage. Since they come in as customers and get paid .65 cents per contract, they literally can buy and sell the same price, and make money. This is killing the market making companies. Think about a penny wide market in an options product. A HFT company can sub penny both sides, and still make money. Whereas, after adding together all the fees, a market making company would need at least 2 pennies of edge to break even.
The HFT companies do not hold positions. They change their markets based on non-public info. They are killing the real liquidity providers. Adding all this together results in the marketplace losing the price impact cushion to order flow, which pure market makers used to provide. HFT decreases liquidity and vastly increases the price impact that orders have in the marketplace. The penny wide displayed market is an illusion.
This is not a good thing for the market in general. More flash crashes with .01 @ 10000 type of markets are in our future, if we continue to allow HFT trading methodolgy to be legal.
