June 21, 2014 2:49 a.m. ET
Peterffy's Smart Plan for Flash Trades
One of high-frequency trading's fathers has offered the SEC a plan to keep HFTs from taking advantage of investors.
It is easy to lambast high-frequency trading as an automated pickpocketing machine that legally steals from investors. It is much harder to mitigate HFT's market impact without getting lost in the cobweb of complex regulations that govern the nation's exchanges and trading venues.Thomas Peterffy, one of the fathers of electronic trading, has recommended a simple solution to the Securities and Exchange Commission that, if enacted, would curtail many of the unfair advantages now enjoyed by high-frequency trading firms.The founder and chair of Interactive Brokers Group (ticker: IBKR) has proposed that all stock and options trading venues randomly delay orders by 10 to 200 milliseconds before releasing them for execution.
He says the delays would keep HFTs from jumping ahead of mutual funds and dealers, and changing prices, before slightly slower systems execute their orders. In theory, dealers could take the money otherwise spent on making certain that they run ultrafast computer systems and make better markets. The delays would keep markets fast and automated, which protects against fraud and manual order-handling errors.Peterffy says the random delay would still offer a slight advantage to speedy trading systems, but it would significantly impair HFT front-running. "For example, even if an HFT's systems were 10 milliseconds faster than a mutual fund trying to do the same trade, the HFT would only trade ahead of the mutual fund around 55% of the time, rather than 100% of the time as in the current market structure," Peterffy advised the SEC. His proposal included a chart explaining the percentage of time that an HFT firm will trade ahead of a mutual fund if both orders are randomly delayed according to his proposal.For years, Peterffy has been concerned that high-frequency trading was weakening the markets, and interfering with the ability of dealers, like his Timber Hill unit, to make markets in thousands of stocks and options contracts.
"Whether HFTs abuse markets or strengthen them is an impossible question to answer because HFTs do both. A solution is required that both retains HFT participation to the extent that is productive (i.e., to the extent that it adds liquidity and facilities price discovery) but yet eliminates abusive HFT trading," Peterffy wrote to the SEC in his early May proposal....MOREHere's Mr. Petterffy's letter to the SEC (4 page PDF)
See also John Dizard at the Financial Times:
Defining high-frequency trading’s US level of evil
...Mr Brennan’s view is fairly representative of the largest mutual fund firms. Thomas Peterffy, chief executive of Interactive Brokers, one of the largest automated electronic brokers and market makers, has a very different point of view. Basically, he thinks that HFTs (remember definitions vary) often act to reduce liquidity when it is needed, and need some very specific controls.
He has submitted an interesting, somewhat technically challenging, proposal in a letter to the SEC. As it says, “We would like to recommend that all US equity and options trading venues be mandated to hold any order that would remove liquidity for a random period of time lasting between 10 and 200 milliseconds before releasing it to the matching engines.”
Got that? Of course. Essentially, Mr Peterffy is saying that the National Market System was designed for much slower computation and communication speeds than are now available, the rules are too easy to game, and you cannot really buy and sell all the time as easily as it appears you can.
“We know all about the speed advantages of HFTs because we have to keep up with them,” he says. “We will do things where we can gain as little as a tenth of a millisecond. But that is crazy, because it does not increase economic value.”
He agrees with academic estimates that the entire direct cost of HFT is only in the low single-digit billions. “But the damage is much bigger, because they compete with longer-term liquidity providers [such as Interactive Brokers], so there is actually lower liquidity as a result of their activities.”
Mr Peterffy set internal teams against each other to see if there was a way to beat his system, and, he asserts, they were unable to improve on its design. Of course he expects the SEC and every other interested party to test his proposal ruthlessly....MORE