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Who Wants to Trade With High-Frequency Traders?

No sane individual wants to take on a professional wrestler like The Rock. Similarly, no sane fund manager wants to trade on an exchange with an HFT fund.

Michael Lewis, author of Flash Boys, and Wall Street's high-frequency traders, have found themselves in a very public media war.

It wasn't Lewis's first exposé about Wall Street. Way back in 1989, he wrote a legendary introductory guide to Wall Street titled Liar's Poker. Lewis's first book opened the door on Salomon Brothers and the famous showdown between the firm's Head Bond Trader, John Meriwether, and the firm's CEO, John Gutfreund, during the 1980s -- a time in which many considered Salomon Brothers the most elite firm on the street.  More recently, Lewis received national fame for his book Moneyball, which documented the extraordinarily successful adoption of statistical analysis in the Oakland Athletics front office. Most recently, Flash Boys has made the general public become aware of the significant advantages high-frequency trading has in the exchanges over the traditional investment fund.

Beyond talking about the advantages that HFT traders have, Lewis has emphasized that many small investors have been scared away from the markets. Many of these investors would have normally invested in the stock market. The funny fact is that retail investors -- those that buy small amounts of shares and generally use limit orders -- will actually find cheaper executions because the bid and ask spreads are narrower as a result of HFT.

Ironically, it is the large fund mangers, such as Fidelity Investments and T Rowe Price, that will suffer the most from HFT. The large buy and sell orders of the huge financial institutions will be detected by extremely fast HFT traders. When the HFT traders detect the institutional orders, their systems "top" offers on either side of the trade. This practice causes the large institutional orders to be "swarmed," which in turn causes worse execution prices and millions of lost investor dollars. The term "swarming" means that when the financial institutions are selling shares the HFTs will short the stock and when the large institutions are buying shares, the HFTs will buy shares in the same security and drive up the price. Of course, the HFT funds' investors will pick up those losses as gains, but why should the mutual funds or the value funds put up with this? Independent exchanges that do not allow HFT trading to occur offer a fantastic value proposition to any long-term institutional fund manager.

I believe in a free society and therefore would never consider the idea that HFT should be banned from the marketplace. Smarter computers allow for better products and better results. But if you look at other industries, unfair advantages are not permitted. Steroids also allow for better play and better results in sports. But, steroids have been banned in many leagues and the NCAA due to the advantage they have given certain players. Maybe some exchanges that want to appeal to the public should consider banning trading practices that hurt investors, just the way steroids have been banned in sports?

There will always be a place for steroids (thank you, World Wrestling), and maybe there should always be a place for HFT in our markets. But just the way no sane individual wants to take on a professional wrestler like The Rock, no sane fund manager wants to trade on an exchange with an HFT fund.

Alexander Fleiss serves as Chairman and Chief Investment Officer of Rebellion Research Partners LP, a Global Macro hedge fund and financial advisory that invests across all asset classes and is based in New York. Mr. Fleiss also oversees the firm's institutional research ... View Full Bio
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