Monday, August 22, 2011

HFT/Algo Trading Is Fine - As Long As The ORIGINAL Uptick Rule Is Brought Back

If the HFT/Algo's had to comply with the original uptick rule, then those firms would actually provide the liquidity they claim to create. My long held view is that without the uptick rule, these firms are really liquidity takers and not liquidity makers -- especially under the mega cap range.

Reason being is that they can force price discovery in volume ranges that just do not naturally exist. This then creates a self fulfilling prophecy of successively lower bids that they themselves are creating. If this isn't a form of front running or stock manipulation, then I don't know what is. Lastly, when they start trading shorts without having to "go get the borrow", then this is electronic paper hanging (naked shorting), which many MM's (market makers) are exempt from. If one spends any time at all thinking logically about the ramifications of all this.....and combines the fact that all of the above can literally be programmed in succession, then it is not hard to see the ultimate form of a rigged game that this creates. Not to mention the huge impact to valuations of publicly traded enterprises.

Much as I knew that the FAS157, no uptick rule and naked CDS spiral was a huge piece of the 2008 financial collapse puzzle, I also know that the reason we have seen so much absolute and relative valuation destruction (in the public markets) since 2007 is substantially due to the elimination of the uptick rule, combined with HFT/Algo trading.

To reiterate, I am completely supportive of HFT/Algo based trading as long as it's combined with the "original" uptick rule. If not, then the practice is only serving to destroy liquidity, force false price discovery and greatly harm public market capital formation. This is yet another assault on US competitiveness.

On the other side, all this is also part of the mosaic that keeps me steadfast and increasingly more bullish the lower we go. The sort of valuation creation we saw with the elimination of just the FAS157 rule may pale in comparison to the ultimate upside we have from the confluence of events that should be forthcoming.....