Anybody remember the last time Brad Pitt showed up in a big-screen movie that didn’t have much blood and gore? Animation aside, that would probably be Moneyball, an absorbing analysis of the moves made by Oakland As manager Billy Beane to rely more on technology-driven data than old-school scouting to put together his 2002 roster. The process didn’t remove all human elements, of course—each selection was very much his call—but it did send a shudder down the spine of every baseball traditionalist. Since then, numerous other teams have (publicly or otherwise) gone down a similar path, which builds on sabermetrics to more accurately gauge true on-field potential.
Odd as it sounds, it’s worth keeping this episode in mind when evaluating the ongoing embrace of (or hostility toward) high-frequency trading, or HFT. For now, the biggest news regarding HFT is that there probably won’t be real news for a while—it’s being reported that for now, at least, the Securities and Exchange Commission (SEC) won’t institute a new set of regulations to curb alleged violations in this contentious arena. Instead, the agency may be working on a broader set of reforms that take on not only HFT but other structural issues as well.
However strict those pending regulations may be, there’s one undeniable truth that has to be faced, and perhaps faced down. While this blog has frequently explored the intersection of finance and technology, HFT takes the entire practice to a very different level. HFT initiatives use sophisticated technologies and algorithms to move in and out of market positions at blinding speed, potentially capturing only a fraction of a cent in a given trade. Yes, human beings do set the proprietary strategies, but after that it’s all machine and no man.
By any definition, it’s much, much worse than the Moneyball metric could ever be for baseball fanatics. More to the point, this is a phenomenon that, despite intense opposition from many quarters, is simply not going away. And far from being relegated to a few outliers, it is increasingly making its presence felt in different sectors of the financial services arena.
To be clear, it’s not as if the regulatory bodies have kept their hands completely off this market. In mid-October, the SEC put the hammer down on Athena Capital Research for making very large trades at the end—literally in the last two seconds—of every trading day for several months. The agency charged that the firm had “crossed the line” in its attempt to affect the closing prices of selected NASDAQ-listed stocks. This was the first true HFT manipulation case, but it’s safe to say it won’t be the last.
That said, the case richly illustrates the complexities inherent in pursuing HFT activities that might or might not violate existing regulations. For example, Athena is nowhere near the size of its brand-name counterparts on Wall Street, yet those few seconds of trading each day accounted for nearly three-fourths all Nasdaq stocks traded during that tiny period—a perfect example of sheer volume having a major impact.
It’s also fair to ask what exactly makes this manipulation in the legal sense. The SEC’s case got help from internal memos specifying that the firm would be “dominating the auction” and “owning the game,” but again, Athena was arguably servicing the needs of its investors. And in fact, unlike other recent settlements, the Athena case does not include an admission of guilt.
The complexities of this particular case aside, there is a larger question here that deserves debate.
For all the advances enabled by technology, many banking practices haven’t changed much—we do the same things we’ve always done, only more efficiently. Yet each advance, from instant online research to the wealth of mobile capabilities now available, has also delivered the potential for real transformation. High-frequency trading takes that variable far outside our comfort zone.
Investment banking has always mandated a measured approach—portfolio managers spend the time needed to study a particular market, analyze the business models and track record of each competitor and even spend time with management before passing it up to a committee that might make a recommendation. (Again, just like those old-time baseball scouts in Moneyball.) But we live in a very different world now, where instant gratification is the norm and faster decisions can mean more than good decisions.
Despite its mushrooming popularity, HFT capabilities and analytics still seem worlds removed from banking as we’ve always known it. But it isn’t—in fact, perhaps even more than in areas such as mobile, HFT has the potential to drastically upend traditional investment practices everywhere, including the most staid and conservative organizations.
It would be nice if those changes happened on our terms. It would even nicer if regulators never had to step in, because we as an industry developed and implemented transparent rules around what’s legal, what’s ethical and what’s practical.
The future isn’t around the corner any more, it’s right here. Let’s hope we fit in.