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- Rubén Blades

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- Art Buchwald

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- Tyler Durden

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- Boondock Saints

Friday, November 23, 2012

Compromised HFT Reports Have Clouded Debate, Unearthed Fact That No One Has Accurate Data

The debate around HFT has been carried on for years now, with strategies and orders only available through "expert-networks" being laid bare for the public understand.  Many pioneers came out and put their reputations on the line because they believed the data they analyzed left no doubt that the current structure of the market is broken beyond technical issues.  Those issues that rest beyond the tech's rest within the regulatory bodies.

Regulators have long relied on the reports published through academics and has the FT points out today, many of the UK Foresight reports (such as this one) have been engineered to support a view, not discover truth (which CC has not compromised in calling out as displayed here, here, and here).

FT notes (h/t @HaimBodek) that the HFT lobby has played a major role in the attempt to "control" the debate.  The quality of the data has been compromised for the quantity in order to surely confuse the public and confound the debate as participants must expend energy to debunk or address issues raised through "nit-picking":
Despite the quantity of research, it would have been useful to focus on conducting deeper research into HFT and improving data quality, while also being more transparent about existing data and methodological deficiencies.
Among the "expert-network" orders exchanges offer, the primary data feeds offered, and the lack of any regulatory oversight, the public and investment community together have learned that there is a very large hole when it comes to data related to actual orders being executed.  Therefore, the majority of research to this point regarding the beneficial effects of HFT have been using indirect data as opposed to direct data relating to HFT orders from HFT firms has extremely limited to specific exchanges, "transparent" HFT firms data, intra-day time periods, or inter-day time periods.

Furthermore, studies have been identified as comparing FT activity among exchanges during time periods when HFT is least active.  These studies have used 1 second time stamping in an era where trades are identified at 25 milliseconds (somewhat like Manoj Narang using End-Of-Day prices to support the argument that HFT provide liquidity, tighten spreads, and reduce trading costs).  Speaking of trading cost, the article also highlights that reports have used execution costs in the UK from 2003 to 2004 which was a period when HFT was not operating in the UK market.

If anything, this article further supports the idea that traders and actually market participants are more reliable than compromised "academic" white papers.  If you want more on HFT read:

From FT:
As high-frequency trading has grown in recent years, so has the industry of academic work devoted to its study.

In this increasingly-politicised world, research that supports a particular point of view has regularly been offered. The scientific rigour of these pieces on both algorithmic trading and HFT is the single most important concern.

We have long held the view that research in this area should be improved, with particular reference to data inputs and the methodological metrics of validity and reliability. The recent 180-page Foresight report published by the UK Office of Science, which contained 31 academic-led driver reviews (DRs) and 22 economic impact assessments (EIAs) provided an opportunity for clarity and leadership.

When the UK looks into a specific topic the work can either be a full government inquiry or a report produced by a Foresight organised unit. In the summer of 2011 Lord Myners suggested that a full government inquiry was appropriate for this topic, but the work went to Foresight. 

From the start, a series of problems have clouded the study such as alleged conflicts of interest through representatives of financial services firms with important HFT clients, banks practising HFT through proprietary trading units and senior staff from non-bank HFT firms all involved in the research; however, if the scientific facts are sound, these conflicts soon dissolve.

The overlay report reads smoothly, like a novel, and provides an interesting, intermediate, and largely qualitative description of a broad range of angles.

However, it is important to remember that it is the DRs and EIAs that underpin it and it is the methodology and data quality of those research reports that provides the bedrock.

Despite the quantity of research, it would have been useful to focus on conducting deeper research into HFT and improving data quality, while also being more transparent about existing data and methodological deficiencies.

For example, one widely quoted driver report on market abuse and HFT does not track trading activity in multilateral trading facilities such as BATS Chi-X or Turquoise or dark pools. Collectively they account for nearly half of FTSE 100 traded volume.

These errors are compounded by the lack of actual tracking of individual orders from specific HFT firms across these fragmented lit and dark venues. Generally, there are two types of research in the area; “direct” tracking and “indirect”, also known as by “proxy”.

The majority of studies do not directly track HFT orders from HFT firms and are generally “indirect”. When combined with the exclusion of trades on MTFs and dark pools these papers struggle to add much to public discourse. As a result, there are only a handful of reports that have conducted direct, primary research.

Another DR uses a UK Financial Services Authority data set but only tracks trading at a one-second time stamp – an age for high-frequency traders. It also restricts coverage to a subset of HFT firms.
Finally, to corroborate the coverage of HFT activity the paper takes the FSA HFT percentage and compares it to activity on the LSE, Chi-X and BATS – yet it does so over the quietest interval of 11.30am to 15.30pm where HFT is decreased. 

Actual coverage, across the full trading day, of the paper’s data set is thus likely to be substantially less than the 70 per cent it claims.

That said, the paper shows that for the top ten FTSE 100 stocks, HFT accounted for “40 per cent” of volume which, considering the above, is remarkably high.

Execution costs were also analysed and show the most significant drop in costs between 2003 and 2004 for FTSE 250 names – a time when HFT was not operating in the UK market.

Overall, it would have been still more beneficial to include additional primary, new, robust, direct data sets that expand this still-developing discipline.

Elsewhere the report notes that “effective regulation must be founded on robust evidence and sound analysis” – the European Union, as well as other regulatory bodies, should certainly bear this effort in mind but, unfortunately, it is neither sound nor robust enough to be a significant cornerstone of leadership for future legislation. 

Perhaps Lord Myners’ suggested full investigation will encourage the release of complete data sets and is an appropriate next step.

Stuart Baden Powell is the head of European electronic trading strategy at RBC Capital Markets