It should concern all of us that regulators are targeting high-frequency trading (HFT) and algorithms for regulations as they view these systems as bad when, in fact, it is purely the programming that could be bad, not the systems.
Way back when, I was trained in an ancient programming art called PL/1, using JCL. That's Programming Language One and the Job Control Language, for those who were wondering. I still remember creating this amazing program that played blackjack. Not very useful, but good training for me.
Walking down the corridor with my hundreds of punch cards carefully placed in order, I still remember dropping them all as I opened the door to the computer room. Result: I had to go through the whole lot to put them back in order... line by line of code, card by card. Now all of this is done by a click and then just 'drag and drop'.
Learning GIGO
A key lesson back then, which was the mantra of every programmer, was: "Garbage in, garbage out" (GIGO). One line of code or instruction in the wrong place would mess up the whole system. So you had to be careful how you programmed, with lots of phase controls and management checkpoints built into the system, to ensure you could not enter anything that would mess up the whole.
After wallowing in the good old days for a bit, you are probably wondering 'what's the point?' The point is that GIGO is a lesson that is just as critical today as it was back then, and regulators seem to be in danger of losing sight of this fact. This suspicion was prompted by recent headlines, such as: "European Parliament piles pressure on dark pools" and "Regulator warns of the dangers of high-frequency trading".
These headlines follow on from the comments of Christine Lagarde, the respected French finance minister: "My natural tendency would be at least to regulate, to oversee [HFT] very strictly and after a cost/benefit analysis of these methods, maybe to forbid it. Or at least give market authorities the power to forbid it in circumstances that are considered exceptional."
Flash crash
This is all in response to the flash crash in the US last May, where share prices bounced around massively during a short period of trading.
This is an issue that has prompted several new global regulatory movements. For example, the International Organisation of Securities Commission is drafting proposals to restrict HFT activities, which will be published next year, and other global regulatory movements are under way to control market activities in order to avoid further flash crashes.
All this movement seems to be saying 'high-frequency trading is bad and should be stopped' when all of this has nothing to do with HFT. It is to do with the programming of the systems by the people who want to be engaged in HFT. And it is this programming that is flawed.
For example, the flash crash was not caused by HFT, but by a plain vanilla trade from an asset manager.
The issue is that the trade sparked rapid movements among the automated HFT systems in response. For example, the Securities & Exchange Commission report shows that, over the course of just 14 seconds, 27,000 contracts of e-Mini S&P 500 futures were traded, half by HFTs. On a net basis, however, only 200 additional contracts were bought in those seconds.
So what this is really showing is that there is a huge volume of trading at razor-thin margins, which is why firms engage in HFT strategies, which will react to abnormal market actions. However, it is the abnormal market action that causes the issue, not the high-frequency trading. Regulation needs to be rethought in this context.
Chris Skinner is an independent financial commentator and chairman of London-based The Financial Services club (www.thefinansier.com)
