High-Frequency Traders Hurt the Little Guy – Really?

So the US government thinks the professional high frequency trading (HFT) community is sucking the retail trader dry?

At least that's what chief economist Andrei Kirilenko (no relation to the NBA basketball player) of the Commodity Futures Trading Commission (CFTC) seems to be saying. In his recent study, Kirilenko's data showed that high frequency traders (aka, HFTs) make more money per transaction (as high as 5.05 USD) when a retail trader takes the other side of the trade.

Even though the CFTC, the government agency that regulates futures and forex or currency trading in the United States, does not endorse Kirilenko's findings (YET), you can see where all of this is probably going; especially in an environment where the US government prefers to make the market a safer place for the Goldman Sachs and other TARP-beneficiaries of the world. Who needs pesky HFTs getting in the way anyway, right Kirilenko?

To the untrained eye, the chief economist's research might paint a tainted picture of the high-speed trader, but this is far from the truth.

High-Frequency Traders are Good for the Markets

The reality is that high frequency traders are beneficial to the markets because they augment the existing liquidity by providing a substantial increase in trading volume. If the active, automated trading algorithms used by HFTs are shut down or severely restricted by the government, the corresponding drop in activity might cause a significant increase in market volatility and rise trading costs for the average investor. Even though Kirilenko limited his research to the heavily traded S&P futures contract, a reduction in trading volume will not be good for any market or contract whatsoever.

Kirilenko tried to highlight this fact during a CFTC Research Conference on November 30, 2012, but his angle of attack makes it all but laughable. He claimed that if retail futures traders (which he calls "Small traders" in his research report) feel as if their profits are being sucked dried, they might leave the futures markets altogether. He said, "They will go someplace that's darker," referring to a less transparent marketplace void of their high-speed cousins.

First of all, Mr. Kirilenko makes it seem as if retail traders are losing because HFT guys are taking advantage of them. This is just plain wrong! Statistics show that, in any financial market (FX, futures, stocks, et al.), the overwhelming majority of retail traders lose money. This has probably been the case for as long as the market has existed. Consequently, it is logical to assume that the retail traders are the least successful out of all market participants; that is, the ones that will lose the most per transaction on average, regardless of who takes the opposite side of their trades. HFTs, on the other hand, are a very advanced bunch; a group that is typically well versed in the creation and implementation of trading algorithms, as well as experts in high level programming. They may not have the assets that a Henry Paulson or the next CEO of Goldman does, but they know their stuff and try to maximize their profits with their experience in trading automation. 

So during times when small traders (the "biggest losers" and not in a good way) face a high-speed counterparty, who will likely be the biggest winner? It's really a no-brainer. Now, just because the high-frequency trader is making a higher average profit per trade when he happens to be matched with a retail guy, doesn't mean that the HFT is causing the small traders loss. Removing the high-speed pro is not the solution. With or without high-speed traders in the financial marketplace, retail traders will continue to lose. They are not losers because they are at a technical disadvantage or because someone is taking advantage of them. They lose because of the same reason why other traders lose in any market environment. They do not have the proper preparation (especially mentally) to tackle the markets as a business – which makes them just another breed of gamblers. Gamblers don't make successful traders and they won't stop their speculation spree just because of HFT either.

Mr. Kirilenko fails to acknowledge any of this in his findings, which seem to be based on the incorrect premise that HFTs are guilty until proven innocent.

So what lies in store the high-frequency trading industry? Our guess is nothing good if the government has its way.

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