RIP High-Frequency Trading?

“It’s like a perfect storm. The cheats are going away, the volatility is going down and the costs are going up.”

Haim Bodek, former head of electronic volatility trading, UBS AG

You could conclude, as Credit Suisse has in a new report, that high-frequency trading is so influential, it “has reshaped the financial industry in its image.”

Or you could conclude, as The Wall Street Journal has, that high-frequency trading is a failing niche on Wall Street.

High-frequency trading uses algorithms and technology to make trades at mega-fast speeds to take advantage of price inefficiencies. Author Michael Lewis brought public attention to high-frequency trading when he published his book Flash Boys in 2014, which claimed that the stock market is rigged.

We’ve railed against HFT as far back as 2011, noting that the majority of trades taking place were being driven not by company performance, but by “tiny inefficiencies that only computers can detect.”

At the time, HFT accounted for 73% of all equity trading in the U.S., up from 30% four years earlier, based on research from TABB Group.

By 2016, though, high-frequency trading accounted for just under half of all stock trading. That was about even with the previous three years, but more than double what it had been in 2006, Credit Suisse noted.

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Prozac Nation

It’s all stress-free bliss these days … at least for anyone who’s not paying attention.

Has someone been putting anti-depressants in the water supply?  That’s one way to explain Wednesday’s non-reaction to the report that the economy shrank by 2.9% in the first quarter – not the 1% drop previously reported.

It would also explain continued investor complacency reported last week, with the VIX (volatility index) approaching single digits.  And it would explain the plunge in junk bond yields to 5.6%, which is a full 3.4% points lower than the decade-long average of 9%.

GDP GrowthYet investors showed that they still have a pulse, when they took the Dow down 100 points after James Bullard, president of the St. Louis Federal Reserve, announced that an interest rate hike may take place in the first quarter of 2015.

So consider this in context.  In addition to the slumping economy, we have Russia’s continued takeover of Ukraine, which is now being overshadowed by the continued takeover of Iraq by Muslim terrorists known as ISIS and the possibility of U.S. military intervention.  We have civil war continuing in Syria and continued nuclear development in Iran, in spite of the lifting of sanctions.  We have U.S. veterans in need of medical treatment being ignored while the Veterans Administration fudges numbers.  We have the missing e-mails of Lois Lerner and six other IRS employees who allegedly targeted conservative groups.  We have continuing fallout in the healthcare industry from the pains of implementing Obamacare.  We have a stock market so overblown that price-to-earnings ratios are at levels higher than they’ve been through 89% of the history of the S&P 500.

So what’s moving the market?  A statement made by a Fed board member that repeats a statement he previously made.

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Swinging Markets Ahead

Volatility is back in a big way.  It’s back not only in the stock market, but in the bond market.  It’s back not only in the U.S., but in China, Japan and other countries.  It’s back not only in developed countries, but in emerging markets.

Just a few signs that volatility has returned:

  • The Dow Jones Industrial Average (DJIA) has had intraday swings of more than 100 points in 10 straight sessions.  On five of those days, the market finished up; on five, it finished down.
  • The Chicago Board Options Exchange Volatility Index (VIX) has jumped more than 40% since May 17.
  • Trading in VIX futures set records for each of the first four months of the year.  May was the third most active trading month ever.
  • The yield on 10-year U.S. Treasuries hit a 14-month high of 2.27% during Tuesday’s trading.

The VIX, also known as the “fear gauge,” jumped from a low of 12.26 on May 17 to 17.25 on Tuesday, but it is still at a relatively low level.  In 2011, it was regularly over 30 and in 2008, it rose over 80.

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