A new book from the heads of US agency broker Themis Trading states that the combination of new regulations and technology have undermined market structure and prohibit effective capital raising through stock markets.
Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street are Destroying Investor Confidence and Your Portfolio, draws on recent experiences including the troubled Facebook and BATS Global Markets IPOs, as well as the infamous flash crash in May 2010.
Such events, said co-authors and Themis Trading co-heads Sal Arnuk and Joe Saluzzi, are evidence that the market has been “hijacked”, further evidenced by continued low trading volume and substantial withdrawals from stock mutual funds.
“An evolved class of leveraged short-term, high-speed traders, sometimes called high frequency traders, who trade massive numbers of shares based on proprietary algorithms, has eclipsed other types of traders,” say the authors. “Not all the stakeholders have realised this or the implications of these changes.”
Arnuk and Saluzzi, who began looking at US market structure issues in 2007, explain that there are two ways to see stock market prices; the fast, accurate feeds used by high-frequency traders to “scalp pennies” from investors and the “slow, mispriced” way that more traditional investors are forced to rely on. They add that the re-emergence of the for-profit stock exchange model has lead stock markets to attract lucrative HFT flow, at the expense of institutions.
Such developments put retail and institutional investors, and publicly-traded companies at a disadvantage, increase risk, volatility and correlations between asset classes and hinder capital raising.
“Investors have pulled billions out of equity mutual funds each month, for nearly two-and-a-half years straight, which is an indictment on what they think of the market structure. Market structure flaws are being exposed very publicly. Markets need to go back to a place that better supports wealth creation and the first step towards this is to minimise the inherent conflicts of interest that exist throughout the market,” Arnuk told theTRADEnews.com last week.
While the authors recognise the work of regulators following the flash crash – which include the implementation of single-stock circuit breakers, a large trader reporting system and a ban on naked market access, they remain cautious.
“There are encouraging signs, but in the past, we have seen many initiatives fall by the wayside.”