CFTC study: High-frequency traders screwing the little guy

Upcoming Fed report confirms what we already knew.

WASHINGTON, December 4, 2012 – Occasionally, The New York Times comes out with an article that’s useful, informative, and nearly politics-free. And so it is with an article today that we discovered via CNBC’s financial website. Penned by Nathaniel Popper and Christopher Leonard, it describes in some detail the results of a soon-to-be-released Federal study of high-frequency trading in the futures markets. The study, supervised by the Commodity Futures Trading Commission’s (CFTS’s) chief economist Andrei Kirilenko, is said to report that “that high-frequency traders make an average profit of as much as $5.05 each time the go up against small traders buying and selling one of the most widely used financial contracts.”

Why are we not surprised? From the very beginning of this column, the Maven has been preaching that computerized high-frequency traders (HFTs) have been a disaster for the markets and have driven small investors from the marketplace almost entirely, depriving the little guy, once again, of an ability to earn a higher rate of return on his fast-depreciating dollars. This new study apparently concurs, concluding that “the high-speeding trading firms that have come to dominate the nation’s financial markets are taking significant profits from traditional investors.”

It’s hard to pinpoint exactly when the HFTs and algos came to dominate the markets. But their dominance certainly came to the fore after the successive market crashes of 2008 and 2009. Terrified small investors withdrew from the market whatever funds they could withdraw, and the evidence is strong that a great many of them never returned.

Sensing the game was swinging in their favor, HFTs swooped in to fill the gap, playing against each other for fun and outsized profit and milking remaining small investors of significant profits by their favorite technique of spoofing quotes at high speed and drawing small investors “offsides” to be fleeced without ever knowing that blizzards of phony quotes had been canceled within nanoseconds of being placed. As a result, small investors end up bidding against nonexistent quotes. The result: they either end up with smaller profits than might otherwise be the case in a non-rigged system, or, on the other side, they end up with larger losses as well. The HFTs pocket the difference, along with their own profits. It’s nothing more than organized corruption.

In a classic contest between the chicken or the egg, U.S. exchanges have defended HFTs, claiming that these trades actually help small investors by “increasing liquidity.” That’s a useful mirage. The potent one-two punch delivered by the HFTs and by the ongoing, depressive effects of Great Depression II have driven so many average investors out of the markets—perhaps permanently—that HFTs now account for some 70% of all trading in the markets according to any number of reliable sources. Exchanges no doubt realize that the HFTs have gone too far. But, given that the HFTs account for a majority of their income and commissions, the exchanges are deathly afraid of killing this dubious golden goose, lest all of a sudden, there might be no trading on the exchanges at all.

The Times report notes that the CFTC “has not endorsed Mr. Kirilenko’s findings, which are still being reviewed by peers, and they are already encountering some resistance from academics.” That’s not surprising. First of all, “peer review” these days is not so much an academic vetting process as it is a systematic censorship of unfashionable or inconvenient truths. It’s a major part of the reason why competent and convincing research that debunks “global warming” “climate change” has rarely seen the light of day. It’s been “peer reviewed” out of publication for ideological reasons.

More importantly, though, with regard to Kirilenko’s study: The current administration—class struggle protestations aside—is run of, by, and for politicians supported by the crony capitalists who run the HFT firms and exchanges. It will be interesting to see if the Feds ever let this report see the official light of day. Or, if it does, just how many of Kirilenko’s findings actually survive in a redacted, sanitized final report. We repeat: the system is rigged against small investors. And The Powers That Be (TPTB) don’t particularly want you to find out.

HFT vultures caught picking at the carcass of yet another small investor’s portfolio. Who knew? We’re shocked! Shocked!!

The Times article notes that the CFTC study “comes as a council of the nation’s top financial regulators is showing increasing concern that the accelerating automation and speed of the financial markets may represent a threat both to other investors and to the stability of the financial system.” Gosh, ya think? The Maven is increasingly convinced that simple, deductive reasoning by the average educated citizen frequently trumps, in speed and quality, the elaborate dances by TPTB, meant to convince us that all is well when all appearances tell us that it is most decidedly not.

Meanwhile, the yo-yo market is set to continue today. Yesterday began with an exhilarating run up which was quickly dashed by a batch of negative economic statistics. We expect that many days this month will behave in precisely the same manner as rumors of this fiscal cliff compromise, or that Iranian provocation will drive the HFTs into daily 180s as each banner headline hits the net.

We don’t have any particular trading plans today, but we always watch for targets of opportunity. We did take a lovely profit yesterday in Restoration Hardware (RH). We’d only been allocated a small amount of shares in its IPO last month, but held the shares just over a month before selling in accordance with our brokerage firm’s house rules for IPOs. Even so, we booked a profit of some 53% in just over a month, and wish to dickens we’d had more of this stock, which we’d never expected to pop so significantly to the upside. A few dozen more trades like this one and we could put this column to bed and head for a fancy condo in the Bahamas. Don’t we wish.

Alas, we have what we have. The fiscal cliff and assorted other nonsense looks as if it may blunt the effects of any traditional, year-end “Santa Claus Rally.” Very short term trading opportunities actually abound, but you have to be in front of your computer all day to take advantage of them because they are incredibly momentary.

We find ourselves actually longing for the good old days of “buy and hold.” Then, you could conduct rational analysis, both fundamental and technical, make rational investment choices, and generally accumulate a respectable portfolio of good, profitable, and preferably dividend-paying stocks you could put on dividend re-investment. You could then walk away, check your portfolio maybe once a quarter just to stay in touch, and gradually accumulate a tidy sum over the course of a decade or two.

No longer. It’s all a crap-shoot now, an educated guess, a high-risk environment made even riskier now by a clueless Federal government and by an array of powerful HFT firms arrayed just out of eye-sight but poised, like a massive flock of sinister vultures, to swoop down at a moment’s notice and peck out any meager profit you thought you might be able to book.

Stay thirsty, my friends.


Disclaimer: The author of this column maintains several active trading and investment portfolios and owns residential and investment real estate. Stock investments currently include positions mentioned in recent articles including IAU, SLV, and EWC.

Any positions mentioned above describe this author’s own investment decisions and should not be construed as either buy or sell recommendations. The current market is highly treacherous and all investors travel at their own risk, so caution should be exercised at all times.

Illustrations, charts, commentary, and analysis are only the author’s view of current or historical market activity and don’t constitute a recommendation to buy or sell any security or contract. Views, indications, and analysis aren’t necessarily predictive of any future market or government action. Rather they indicate the author’s opinion as to a range of possibilities that may occur going forward.

References to other reporters, analysts, pundits, or commentators are illustrative only and do not necessarily represent an endorsement of such individuals’ points of view. If specific investment vehicles are mentioned in any article under this column heading, the author will always fully disclose any active or contemplated investments in said vehicles.


Read more of Terry’s news and reviews at Curtain Up! in the Entertain Us neighborhood of the Washington Times Communities. For Terry’s investing and political insights, visit his Communities columns, The Prudent Man and Morning Market Maven, in Business.

Follow Terry on Twitter @terryp17


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Terry Ponick

Now writing on investing, politics, music, movies and theater for the Washington Times Communities, Terry was formerly the longtime music and culture critic for the Washington Times print edition (1994-2009) before moving online with Communities in 2010.  



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