Apr 5, 2014

Mark Cuban on the risks of high-frequency trading

CNBC: [Michael] Lewis maintains that high frequency traders are front running smaller investors in his words, legal front running is how he puts it.
Cuban: Yeah, they are. I mean, there's no question about it. You know, they know if you go to the store every day to get a snickers bar, well, if i run to the store first, get a little bit of a discount and sell you your snickers bar, you know, they're going to make a little bit of money. especially if they do it millions of times. it's almost like taking advantage of a regulation that's not quite right. it's what they do. and they've been doing it for a long time. and it's reality. but i don't think that's even the greatest risk of high frequency trading. that's just part of the deal.
CNBC: What is the greatest risk then?
Cuban: The greatest risk is that, A) there's no such thing as buck-free software.  All this is software-driven. It's actually even going to processor driven.  And because of -- because there's no such thing as bug-free software, when you have fat finger bugs, you don't know what's going to happen to the market. So there are structural risks, trading risks, and I think that plus the fact that when you have algorithms trying to figure out routes and how to get ahead of orders.  It's not like there's just one player jumping in front of all these orders. you've got all these different algorithm traders, it's not about small investor or any investor giving up some amount of money to somebody who jumped in front of them, the risk is all these different high frequency traders playing a game with their algorithms to get in front and make that trade. Because we don't know the in factorial all the ways they may interact and the negative consequences that occur as a result, that introduces a market risk. That market risk has an unquantifiable cost.  We saw it in one instance with the flash crash.  We see it every day with little mini-flash crashes. We've seen some -- it's gotten a little bit better with the circuit breakers per stock, but we just don't know.   And that's even without the possibility of a malicious algorithm being intentionally introduced into the mix.  There are so many things that can go wrong as all the different high frequency traders jockey to get in front of that order. That to me is the biggest problem.  I think as a result you'll see people not staying with their positions as long because they're not quite sure what's going to happen with the market.  When you see something start to go bad in the market, they don't trust the system to say, you know what, somebody will jump in there and pick up the trades.  For all they know the chair might be pulled out and the whole market could fall even further.  And then we have such strong correlations between different markets and different types of equities and financial devices that even though there are circuit breakers involved, one trade down, limit down, might lead to something happening in another, might lead to something happening in another equity might lead to something happening in a full market and who knows how far down that can cascade.  All those things introduce risk.  All those things take a lot of money to try to understand and combat.  Because of that that's a cost...
~ Mark Cuban, as appeared on CNBC, March 31, 2014

No comments: