Mary Jo White, head of the SEC told Congress that the allegations in Michael Lewis’ new book about high-frequency trading markets are false. She bluntly stated that the “markets are not rigged.” I know Mary Jo White personally and I am no fan to say the least. However, on this comment she is correct.
White’s comments came almost a month following Lewis’ book was published. Lewis has re-ignited a fierce debate over the role of high-speed trading. The proposition is that the computers are fast and leave some investors at an unfair disadvantage. Lewis has alleged that high-speed traders are front-running orders whereby the firms are able to quickly identify an investor’s desire to buy stock, rush to buy it first and then sell it back at a higher price.
Lewis’ book has sparked the FBI, the U.S. Attorney General, New York state prosecutors and the SEC all into action to investigate the practices of high-speed firms. White made it clear that if computers try to anticipate what a client will do, that “is not unlawful insider-trading.” There is a substantial difference between computers responding fast and having a look at orders before they are entered.
When I was trading for the Onassis holdings in Platinum, I had to get approval and prove to the CFTC that the amount of metal actually existed since it was up to 40% of the market cap. Even back then, trying to trade when everyone knew what you had, was not easy to say the least. Nonetheless, it taught me HOW to trade.
I would have to buy gold and then silver to set the stage where the market-makers attempt to read you and move the spreads between bid and ask in the direction they think you will go. Buying related markets made them think I would buy platinum. The spreads moved in that directions and then I would sell taking deliberate small losses in the gold and silver. This was not “front-running” for they did not know the order in advance. Had I gave an order and they jumped in front of that order assuming they would cover using my orders, that was front-running.
There is still a way to set-up the high-frequency trading system that they would not be capable of reacting in a real poker-game.
Consequently, I am no fan of Mary Jo White. I have every reason to disagree with her just because it is her. However, analysis cannot be personal. So sorry – she is right. This is not front-running, it is just rapid response time in anticipation of what is to come. That is not illegal for even then it is not 100% guaranteed trade. I would bet anything I could deal with a high-frequency trading system for they lack human intuition.