In another (super nerdy) paper in the Review of Financial Studies in 2012 (from David Easley, Marcos Lopez de Prado and Maureen O’Hara) the authors challenge the very idea of even thinking about “time” when it comes to trading. They posit that what really matters is a new metric where all you care about is how many trades happen. The ideas is that “slow” trading (an ETF that trades 100 times a day) has similar characteristics to “fast” trading (an ETF that trades 100 times a second). All that changes is the nature of useful information.
In the “slow” ETF, you care about “slow” data, like an earnings release. In a “fast” ETF, where the holding period may be minutes instead of weeks, you care about “fast” data. And what kind of data is that? Data about the nature of trading itself.
By getting access to the “fast” data, the HFT crowd gains an edge because they can anticipate order flow and get ahead of it. Let’s be clear—that’s a bad thing. All else being equal, having inside information about any part of the capital markets process is likely something that we, as a society, want to squash as best we can. We want a level playing field. There’s something uniquely American about that, and I’m all in.
Regulation FD (Fair Disclosure) is supposed to make any inside information a no-no. That’s the big argument many folks are making about HFT early information—it’s against Reg FD. And it’s certainly against the spirit of it. Still, there are plenty of folks out there who just consider this traders being rewarded for being smart, and that smart traders have always had an advantage.
Issue 2: Bad Actors
No, I’m not talking about Nicholas Cage. I’m talking about how HFT enables bad behavior.
The second thing HFT brings to the party that can be outright negative is an opportunity for abuse. Here’s where I actually have some concern. While the early-information advantage is a bad thing, the reality is it’s not actually costing the long-term, buy-and-hold investor much, if anything. It’s an annoyance, and one I’d likely stomach for a smoothly functioning, penny-spread market.
The problem is that HFT firms, by nature of their hardware and access, can actually break the market, essentially at will. Numerous reviews have talked about “quote stuffing” and other nefarious strategies deliberately being used to expose cracks in the actual market infrastructure—cracks that allow the bad actor to get executions when nobody else can. Obviously that kind of activity should be (and is) illegal.