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February 10, 2014

High-Speed Trading Isn't About Efficiency—It's About Cheating

“I was a senior in high school, and I was staring at NBA legend Red Auerbach. He’d coached the Boston Celtics to nine championships in 10 years, won seven more as an executive, and, a bit less notably, gotten his first coaching job at our school way back when. He was 85 years old, but he lived nearby and had finally agreed to come back to be feted.

“Then Auerbach turned to life lessons. “Everybody always asks me how to gain a competitive edge,” he said, “and I’m always surprised because the answer is so obvious.” Eighteen-year old me knew where this was going. He was going to tell us to work hard, that successful people prepare for their luck, yada, yada, yada.

“You cheat.”

***

“That brings us to high-frequency trading (HFT) hedge funds. These funds use computer algorithms—a.k.a.: algobots—to buy and sell stocks at incredible speeds. We’re talking milliseconds. The idea is to react to any market news or inefficiencies before actual humans can process them. And it’s any idea that has taken over stock trading: algobots make up about half of all stock transactions in 2012 (which is actually down from its peak of 61 percent).

“It’s Wall Street at its most socially useless. HFT funds aren’t allocating capital to where they think it’ll be most productive. HFT funds are allocating capital to where they think other people will put it 50 milliseconds from now. It’s a tax on everybody else. And it’s a tax that has basically no benefit. Sure, HFT funds defend themselves by saying they’re increasing liquidity, but increasing liquidity is the last refuge of bullshitters. Just look at the chart to the left from Felix Salmon. It shows that the cost of trading has fallen as our computerized markets have become more liquid, but almost all of the drop happened before HFT. Economist Paul Samuelson had it right all the way back in 1957: knowing (or trading) something one second before everyone else is personally profitable and socially pointless.”

***

Read full Atlantic article here

 
 
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