High-frequency traders are “market jackals” and not market makers, in increasingly electronic markets, JonesTrading Institutional Services said in a White Paper released Tuesday.
“HFTs are akin to market jackals, scavenging off the legitimate strategies of longer-term investors while simultaneously touting their importance to market health,’’ said JonesTrading director of marketing Scott Cooper in a paper on the Flash Crash called “May 6, 2010: A Market Odyssey.”
He likened the results of relying too much on computers instead of humans to the takeover of a space mission in “2001: A Space Odyssey,’’ a 1968 film from producer Stanley Kubrick.
“What happens when the machines take over and humans cannot control what occurs? May 6 was the first and likely not the last such event either in kind or duration,” Cooper contends.
Owing to Reg NMS, decimalization, the collapse of spreads, the speed of execution and co-location of trading servers in the facilities of trading venues’ matching engines, “the roles of specialists and market makers, for all intents and purposes, went away at the precise moment that they were needed most,” Cooper wrote. “This creates a liquidity vacuum when markets are stressed. The decline of human interaction in markets and the rise of the bulk of trading being machine based has led to the illusion that machines can and will exercise the same judgment as people will.”
In price-driven auction markets, specialists acted as “ the liquidity of last resort,” he asserts, “and in order-driven dealer markets, market makers served this role.”
On May 6, high-frequency traders “and everyone else” withdrew liquidity. “In effect, there was no liquidity of last resort on May 6,’’ he says.
Cooper asserts that high-frequency taders, if they are the new market makers, “must be required (to) fulfill the traditional specialist or market maker role,” assuming risk and standing “up for the issues in which they make markets..
“Further, there must be a role for traditional asset managers to be incented to return to fair treatment in the markets precisely because they represent investor liquidity and interest,’’ Cooper says. “Because people can build quality machines, doesn’t mean machines will ever build a quality market.”
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