What Business is Wall Street In?

[1] http://blogmaverick.com/2012/09/04/facebook-handled-their-ip...

But the benefits of market making tail off with frequency - would you mind waiting another hour for a deal at 518 or even a whole day? To a trader its unacceptable, to an investor, its a coffee break.

But what drives HF trading is trading - as markets become more efficient trading opportunities, as you point out, vanish. So smaller amounts of arbitrage need to be leveraged with larger amounts of cash to get the same return.

We want nice safe retail banks who make a tiny fraction on the movement of wages from company to employee to shops each year, and bundle it all up into mortgages and ATMs. They keep society oiled

By the same token we (society) wants nice safe boring market makers. Who efficiently take a tiny fraction of each trade and keep liquidity in the markets for investors.

I cannot prove it but the amount of margin gained for investors who hold for >1 year through the existence of HF trading is probably small - you can now get 515 offered quickly. 5 Years ago? 520? If that would have prevented you investing, maybe it was the wrong company.

His main point: Wall Street doesn’t know what business it is in. Wall Street has nothing to do with creating capital for businesses, its original goal.

He's saying wall street should have an incentive to create/raise capital for businesses, not invest in marginally profitable trading strategies like HFT.

The opportunity cost of wall street investing in trading is that other pursuits like capital raising get less or no attention.

So it's not that HFT is necessarily good or bad, it's that it's a distraction that's not going away, to the detriment of other potentially more value-creating pursuits, like raising capital for new companies.

Given that the rejection of HFT has to be overbroad. If they liquidity they provide is the sort of that supports the functions we like, who cares what their holding periods are?

It certainly seems true that Cuban is right about "hacking" the market insofar as yeah, a good deal of HFT sounds like exploitation of rules and procedures to avoid creating the fair market intended. But that means there is "bad" liquidity, which doesn't serve our purposes. Okay, so let's write rules that better serve our purposes for liquidity. (And if we're worried about market distortions from bad trading liquidity, what about the market distortions from Fed provision of currency liquidity? The wash of cash has lifted all asset prices, it's hard to see economic signals when price correlations are moving to one.)

Cuban seems to think we can do just that by manipulating investor incentives -- give them tax breaks for holding periods, tax transactions, etc. But all of these just make the market more complex, and increase the differential between investment categories -- all of which creates more incentive for financial hacking and further detaches pursuit of financial return from realization of economic return. It makes the rules less comprehensible. And it gives the politicians and regulators more to do in the markets, which makes them more attractive targets for lobbyists. He's increasing the incentives for soft corruption while making it harder to spot, the consequences are easily predicted.

Cuban is a smart and pragmatic guy with billions of reasons to think himself smarter than the average bear. Part of his smarts are an ability to keep it simple, and an instinct when things are out of whack. But here that instinct have lead him through simple on to simplistic.

It has always been in the interest of high volume traders to hide their intentions just as it has been in the interest of all other market participants (including other high volume traders) to attempt to discover those intentions. In this sense, trading now is exactly as it has always been, although it occurs at a more rapid pace.

"Otherwise the HFT spots it (and they usually do) and then front runs all of the trades, just skimming pennies off. What use are they?"

Please explain why it is bad/wrong/unlawful/unethical that other traders may act when a large trader does a bad job of hiding his intentions.

"The majority of the trades are not making markets at all, they are just zipping back and forth to collect pennies."

I don't understand. What do you mean by this?

"If they were market makers then they would hold inventory, but they never do."

I assume this to mean that you believe that the definition of "market maker" should include a reference to the length of time one holds a position. If you demand that to be called a "market maker," one has to hold a position for a minimum amount of time, then you will exclude some market participants from being so designated. I don't understand how the definition of this term is relevant to the discussion; please explain.

"NOBODY believes the "liquidity" story."

I assume that by ""liquidity" story" you mean the idea that HFT firms increase liquidity (more size with which to trade, at a better price) and that this is to be valued. Is this not the case?

"and what about flooding the market with fake bids to cause opponents to get overloaded ?"

Deliberately entering unbalanced (one-sided) orders without the intention of trading so as to manipulate the market is illegal. This vague idea is a serious infraction of SEC rules that carries significant fines and penalties. See: http://www.finra.org/Newsroom/NewsReleases/2010/P121951

"or running tracer LFOs spitting out strange bid patterns just to see if they can detect another hidden program ?"

I'm not familiar with "tracer LFOs," please explain what these are. If they are orders or order submission strategies intended to gauge market interest, do you think that they are bad/wrong/unlawful/unethical? If so, why?