
So begins the latest online article from the Huffington Post, which chronicles the accusation that Mr. Lewis, a best-selling non-fiction author and financial journalist, levels at the Wall Street machinery. During an interview with 60 Minutes that aired just a few hours ago, he proclaimed, "The insiders are able to move faster than you. They're able to see your order and play it against other orders in ways that you don't understand. They're able to front run your order."
The advantage gained from high frequency trading is often narrowed down to the nano-second but for the firms managing big-time funds, it can amount to a significant payout if applied correctly. "One hedge fund manager said, 'I was running a hedge fund that was $9 billion and that we figured that the, just our inability to, to make the trades the market said we should be able to make was costing us $300 million a year.' That was $300 million a year in someone else's pocket," Lewis said.
So a hedge fund manager lost out on $300 million...boohoo! Cry me a river. Capitalism, as I asserted in full-length article, espouses, even demands innovation in all industries to make them quicker and more efficient. Why should the financial markets be any different? In fact, it would be excruciatingly hypocritical to criticize high frequency traders when the advent of the internet has allowed all of us to access more information and execute trades based on that information than people of previous generations. Are we then to say that using technology is allowable in the markets but only at the speed dictated by the slowest person on the trading room floor?
Please don't get me wrong : I am not naïve to be believe that everything that goes on in Wall Street is on the up and up. Far from it, I have personally criticized the albatross that it is time and time again. However, we have to be intellectually honest with our allegations and in this case, the mere existence of high frequency trading is not enough evidence that the markets are rigged, as was stated by Mr. Lewis.
One of the misconceptions about high frequency trading is that it amounts to risk-free arbitrage. I believe that this is an over-simplification due to the fact that such trading systems can exacerbate losses if the wrong inputs are calculated into the algorithm or the trader is woefully incorrect about his speculation regarding market direction. Recall the failure of Long-Term Capital Management in 1998 and the widespread implosion of quant funds, or hedge funds that employed extreme mathematical models, during the summer of 2007. These were highly capitalized investment firms that relied on computerized systems and physics-based models that very few people had access to, yet their hubris was their undoing.
High-frequency trading is just another system that is a product of the capitalist ethos. Getting rid of it would be impossible since it distorts the very incentive to gain a competitive edge and thus endangers the essence of a free market.
For more information regarding this topic, please read my article, "Race, Sex and The Rig."