High Frequency Trading and Finance's Race To Irrelevance

hype7 (239530) writes 'The Harvard Business Review is running a fascinating article on how finance is increasingly abstracting itself — and the gains it makes — away from the creation of value in the real world, and how High Frequency Trading is the most extreme version of this phenomenon yet. From the article: "High frequency trading is a different phenomenon from the increasing focus on short term returns by human investors. But they're borne from a similar mindset: one in which financial returns are the priority, independent of whether they're associated with something innovative or useful in the real world. What Lewis's book demonstrated to me isn't just how "bad" HFTs are per se, but rather, what happens when finance keeps walking down the path it seems to be set on — a path that involves abstracting itself from the creation of real-world value. The final destination? It will enter a world entirely of its own — a world in which it is fighting to capture value that is completely independent of whether any is created in the first place."'

Comments

A cautionary tale

[6Yankee]

If you have the time (and if you're at work, of course you have the time!), I recommend The Great Hargeisa Goat Bubble. One guy gets his last goat killed by an aircraft so he can claim twice its value from the airport, and it all goes wrong from there.

Soon the shortage of actual goats led to a booming market in goat futures, goat options and increasingly arcane goat derivative products. This trade in young, unborn, and even theoretical goats allowed yet more money into a market whose only bottle-neck or brake up to this time had been the physical shortage of actual goats.

...until the whole thing comes crashing down.

Problem with public companies, not HFT

[michaelmalak]

The HBR article notes two issues:

1. HF traders don't participate in stockholder meetings and thus their trades are divorced from steering company direction.

2. CEOs are focused on next quarter profits and, aside from a few corporate founder CEOs, are not able to have their company innovate.

The first problem is not specific to HFT. Even buy-and-hold mom and pop cannot influence a stockholder meeting because they don't own enough shares to meaningfully do so. The exception proves the rule: a bunch of Palestinian human rights defenders got together, bought some Caterpillar stock, and got a human rights issue on the agenda. Even with all that effort, the measure did not pass. And it was a large effort in coordinating. Individual stockholders usually do not organize, coordinate and campaign. (The "transaction cost" is too high.)

The second problem is caused by SEC, SOX and CEO compensation structure, not by HFT. The HBR article suggests without actually accusing that HFT is the cause.

HFT serves little purpose other than providing market liquidity (and even at that arguably harms it given the flash crash), but it's not to blame for the above two pre-existing problems of today's markets of publicly traded companies.

Re:Technological solution

[alexander_686]

What you are suggesting is book market – expect for the random part. Book markets in recent years have fared worse than quote driven markets – much worse. 5 to 10 cents worse per share – much greater than the fraction of a penny that the HFT steal.

You might want to a look at IEX. They use a quote driven model with a 350m delay. Lewis have them high praise but even they have had criticisms that they can be exploited.