A report by U.S. Commodity Trading Futures Commission (CFTC) chief economist Andrei Kirilenko that shows the advantages of high-frequency traders over small investors is turning the public eye back toward trading and technology.
The report states that high-frequency traders cost retail investors roughly $5 per contract, although the study has yet to be peer reviewed. Now small investors who lack the aid of algorithms and supercomputers are fuming at their $5 disadvantage. From the New York Times:
The most aggressive [traders] scored an average profit of $1.92 for every futures contract they traded with big institutional investors, and made an average $3.49 with a smaller, retail investor. Passive traders, on the other hand, saw a small loss on each contract traded with institutional investors, but they made a bigger profit against retail investors, of $5.05 a contract.
The average aggressive high-speed trader made a daily profit of $45,267 in a month in 2010 analyzed by the study.
When Kirilenko—again, the author of the study—was asked where retail investors might go now that they appear to be losing a zero-sum game to high-frequency traders, he responded: “They will go some place that’s darker.”
CFTC Report has Dissenters
The CFTC report does have dissenters; in particular, Dealbreaker’s Matt Levine scoffs at the notion that the traders have somewhere else to go, or that would leave the market given that HFT’s cost them “one one-hundredth of one percent” of their investment. To Kirilenko’s suggestion that traders would leave the market, Levine responds:
That seems extreme for less than a basis point! Especially when you consider that small traders lose money to everyone, and they lose more to non-HFT market makers (i.e., whoever would be selling to them in less transparent markets) than they do to active HFTs (i.e. the traders who make up the bulk of the transparent, HFT-infested markets).
The Threat of the Flash Crash
Although the NYT’s piece on the CFTC report is ostensibly about the advantages wielded by high-frequency traders, it has managed to reinvigorate a debate about flash crashes and the risks of “inhuman” trading.
Daily Finance notes that “60 percent of all trades on U.S. stock markets are executed as high-frequency trades, and therein lies the danger: With the majority of equity trades now done by mindless computer programs, there’s the potential for runaway, market-crashing errors.”
These “inhuman errors” in the form of “market events” and “flash crashes,” are recapturing the public imagination, but it doesn’t stop there. A new Reuters report states, “Almost a third of fund managers believe automated trading has had its day.” These managers are moving to “human-led trading models.”