Mark Cuban: High-Frequency Traders Are the Ultimate Hackers

You might have different auction interval times based on the volume of the particular market or stock. An AAPL auction happens every minute, but some low volume securities might trade once an hour or even once a day.

Google "HFT frontrunning". The issue is that HFT algorithms can use their superior speed and the ability to cancel orders to essentially figure out what institutional buyers are bidding, and then front run the market to buy up shares in front of them. This would be prevented in my system by the black box auction and trading on an interval.

This post is being used as somewhat of a stalking horse for any number of other agendas and soapboxes, which I guess isn't surprising, so I'll join the fray.

1. There is a misconception about market makers and the nature of a spread. In particularly illiquid markets, market makers allow you to buy and sell immediately. This is a service. The spread pays for this service. The more liquid a market is the lower the spread (eg it is essentially if not actually zero on US Treasuries);

2. For those questioning our brightest and best being "wasted" on HFT, I see comparatively better value on all the bright minds being wasted on social networks;

3. Finance is a constant arms race. The flavour of the month is HFT. In 5-10 years it'll be something else where low-latency transactions are just taken for granted. This kind of market is a gold mine for innovators as the existing players need a certain amount of innovation just to stand still (relative to the other players). There is classic "mine the miners" opportunity here;

4. There is a lot of highly-leveraged trading that goes on, automated and otherwise, beyond the world of HFT. (I believe) Warren Buffett describes this as "picking up nickels in front of a bulldozer" [1]. In extreme market situations, market models go out the window and the highly leveraged are the first to go to the flames. Just ask Bear Stearns [2] with its 35:1 leveraged ratio.

5. Financial institutions have access to way more data and cheaper (typically free) transactions compared to the average investor. It's common practice to do things like whipsaw the market to hit stop loss orders and the like. Honestly, unless you're a bank in the short term it is an insider's game;

6. A lot of the problems with the lack of transparency, assymmetry of information between parties and bad behaviour (like flooding exchanges) comes down to a failure of regulation. The SEC is either toothless or has been subverted by political interests. Much of what happens in the US just doesn't happen in Australia (to the same degree at least). Just take all the fake documentation in the US housing bubble. How bank executives, loan originators and the like didn't go to jail for this is really astounding;

7. Banks and market funds have limited to no downside risk. If things go horribly pear-shaped the US Federal government will--and has--bail them out. This breeds an adverse appetite for risk. I subscribe to the view that the Federal Reserve, the World Bank and the IMF are in large part welfare for investment bankers; and

8. Banks and funds are too large. If something is "too big to fail" then it's too big and needs to be broken up.

That is all.

[1]: http://en.wikipedia.org/wiki/Long-Term_Capital_Management

[2]: http://en.wikipedia.org/wiki/Bear_Stearns

Serious question: Aren't stop-loss just another form of algorithmic trade? I understand their purpose (in principle), but perhaps its not an intelligent move for a long-term investor...? (Or to put it another way, perhaps the risk mitigation aspects of stop-loss trades are not properly valued.)

This is not efficient. If you use interval bidding, there will frequently be gaps in market prices. Remember that at any instant, the order book (bids and asks) represents only a small portion of market sentiment (real demand and supply). The market prices move smoothly when people are able to react to order changes and price spikes. If it's a black box, it's very easy to manipulate the market in a massive scale.

For example, AAPL is $600 now. Under your system, $600 is the price that generated the highest volume in previous bidding event. (There will be sellers placing orders under $600, and buyers over $600 - they'll all be settled at $600 and the exchange obviously wants to maximize this overlap, hence the price). If a large institutional investor wants to manipulate the price, he can place huge buy and sell orders at $700. And very likely in the next bidding event the price of AAPL will move to close to $700, because that will be the price that maximizes the overlap. This is almost impossible in current market system, because you have to continuously buy from all the sellers who are willing to sell at $700 to get the price. Meanwhile, traders (especially day traders) will add to the order book to take advantage of this irrational move. In a black box, irrational moves can't be detected and corrected by other market participants. So you can't really get the idea of the actual matching price in a black box system.

When you place a buy order, if there's overlap with any sell orders, it should be matched and executed instantly. Otherwise it will stay in the book to wait for sell orders. The market equilibrium is reached when the spread is minimal and no trade occurs. (Yes, this is in theory.) However, in your "efficient" system, there's no market equilibrium, because buyers and sellers are discouraged from making their real demand and supply invisible. The exchange has the incentive to maximize trade volume, so the only way to result in zero volume is no overlapping orders in the entire interval, even when the buyers are sellers have no knowledge of any orders. This only happens when people have no confidence or interest to trade at all. Again, it makes market vulnerable to be manipulated.

In China, stock exchanges partially adopted your idea. In Shanghai Securities Exchange, the first 10 minutes (9.15am to 9.25am) of the day is set to be non-continuous bidding period. In Shenzhen Securities Exchange, the first 10 mins and last 3 mins are the same. This was introduced to reduce market manipulation because the order book is empty at the beginning of the day. However, after the period, trade starts continuously and all remainder orders in the bidding event will automatically enter the order book. This way, the price movement of the whole day is smooth with minimal spikes, while the opening and closing prices reflect market sentiment more accurately.

Generally, the more the visible orders, the more smoothed the price. Interval bidding discourages order placement because the next price is absolutely unpredictable. It can be adopted in extremely illiquid market situations though.