Treat the cause, not the symptom

Christian VoigtThe current MiFID II draft proposes a minimum duration for any order of 500 milliseconds (see Should have gone to Specsavers!). Politicians seem to believe that installing a minimum duration for orders will halt the HFT ‘madness’ and bring some much needed calm to the market. Unfortunately, it looks like they are going to treat only the symptoms and not the cause.

Trading in an open limit order book (aka continuous trading) is a ‘Winner-Takes-All’ game. If three traders have the same strategy, only the fastest trader will make a profit. It does not matter whether you cross the line in second or third position, you will make no money. That explains why so many trading firms invest heavily in technology. If your trading strategies are fairly similar to your competitors’, you need to protect yourself by putting on your running shoes. Unfortunately, minimum duration does not change this; your ability to be a microsecond faster than your competitor is what makes the difference. Minimum duration will only decrease liquidity provision by HFT firms. Yes, you may sneeze at their liquidity because it is allegedly harmful, but I see it differently. There is no such thing as good or bad liquidity; there is only more or less liquidity.

If politicians are serious about calming the market they should try to treat the cause and not the symptoms. The main symptom is excessive order cancellation rates but the cause is the ‘Winner-Takes-All’ issue. Thus, it must become less important to be the first to arrive at the trading venue. How about abolishing continuous trading? Instead, venues could have many small call auctions (like opening or closing auctions) one after another, where each auction only lasts 500 milliseconds. To the human eye it looks like good old continuous trading, but for machines the incentive to be the first would largely disappear. The technology race would slow and the politicians would calm down.

2 Responses to “Treat the cause, not the symptom”
  1. Colm Furlong says:

    I am going to ignore the fact that you suggest that we might stop continuous trading in Europe and put me and your colleagues out of a job, in the same way as I am currently ignoring the fact that the European politicians think we should not have Direct Market Access. Although I know (hope) you are joking, where I am worried is that the DMA thing is not a joke! Maybe it will go the same way as the Tobin tax and they go ahead and ban DMA in France…I mean Basildon.
    On the issue of cancellations and minimum resting periods, I see this as Herr Ferber wanting to be seen to combat the fast traders in MiFID at a political level. The fact that they are focused on reducing the rate and speed of order cancellations does not make markets less volatile at all, in fact it likely has the opposite effect.
    This follows where some of the exchanges have gone recently in penalising high cancellation rates and “transient” and disappearing liquidity – albeit for differrent commercial reasons. So the main front is with the “Market Making” HFT players. It looks like hitting resting liquidity at breakneck speed is OK though and latency arbitrage and the race towards zero latency is deemed fair game.
    The upshot of this is almost certainly less liquidity, as you say. The liquidity that the Eurocrats want on the market is the good old fashioned institutional investors but I cannot see them coming in where the HFTs abandon as they will be picked off like chickens by the HFT snipers while they cannot cancel their orders.
    Doesn’t make a blast of a difference when it comes to things like the US flash crash and volatility where the disappearance of the liquidity from HFT players was highlighted by various reports and regulatory probes to be one of the exacerbating factors.
    In Sep 2010 following the flash crash the regulator stated that it judged that quote stuffing and mass cancellation of orders did not contribute to the 1000 point drop in the DJIA in 5 minutes. If anything, HFTs stepping away from the quote made matters worse.
    Strange that there seems to be some contradiction in approach in MIFID, in that, there is separately a requirement for continuous quoting by HFT algos but the regulation seems to actively discourage the provision of quotes in the latest papers by not allowing for fast cancellation.

  2. Christian Voigt says:

    I fully support your concerns regarding the unneccseary rules for HFTs and the implied negative effects. Unfortunately, this does not make the regulatory risk go away. If you accept that politicians want to change something, then having many small auctions is the least evil. It certainly is better then having a minimum duration. In a world with many short auctions, HFTs could modify and cancel orders without any restrictions. They still would receive order book data they can use to model their strategies. HFTs could continue to efficiently monitor their risk exposure. The only thing that would change is, that executions would be slightly delayed to allow other market participants to join the trade. Yes, this may not be ideal, but it is much better than not being able to cancel your orders, when markets go into havoc mode.

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