KCG and the false Black Swan event
What happens when Michael Lewis begins a book tour by stopping off at 60 minutes and claiming markets are rigged?
Well a number of things will happened:
1) The usual Lewis crowd will come out and claim markets are rigged becasue they lost money in the markets in the past and can't accept the possiblitiy they lost it on their own. The markets must be rigged.
2) This book created a market sell off and the only publicy traded HFT is KCG so the stock was slammed.
3) Vinnie Viola, targeted in the book withdrew his VIRT IPO.
Some of you in the loser and Luddite camps will not like what I say but HFT is here to stay. It is in fact a way the exchanges encourage additional business. The servers are housed inside the exchanges. The difference between Knight and a dark pool is that we know who Knight is. It has opened books to the public and shareholders. It is not laundering money or moving in the darkness. Yet Knight was slammed over 30% since this book publicity began. Yet Knight has a Book value of $12.4 so it is selling at a 22% discount to book.
Who doesn't like HFT: the enemy list. It is the old school large trader that has not adopted the newer technologies. The old dirty traders would often produce unsubstantiated rumors. Mathematically these cannot be discovered as true or false so for the machines, it presents a mathematical problem. It is exactly akin to a machine playing chess with a man. The machine looks at this move and starts to try to test the varacity of the move against probability. What the HFT machine does is tries to poke a stick at the rogue trader just as a small trader might do with limit buys and short orders. They will also look at the options trades and coorelate the rogue conduct. If the machine suspects a false swan, it attacks and breaks the back of the rogue trader. Without the machines, the rogue traders could not be discovered. So the old school cheats don't like HFT.
Ray Dalio says that we are in an extended periord of deleveraging. The companies that will do well in this are those that stick closely to the productivity curve not the boom bust companies. KCG benefits stock trades by improving liquidity, narrowing the bid as spreads and acting as a market maker when bids dry up. With markets moving rapidly toward 10 trillion dollar markets, HFT is here to stay.
The language by Lewis that markets are rigged and that front running [from horse racing cons in the 1920s] is patently false. There will always be inequities in information. Your wife's best friend knows long before you about your wife's infidelity with the pool cleaner. That will never change. There is always somebody with insider information. HFT does not have insider information. They are only capable of exploiting hardware at the millisecond level. That's life. I can promice you that as a chess player, you cannot beat a machine at chess, nor can you outrun a racecar. What you might view as a shortcoming or unfairness is simply reality. In now way does this disrupt your capacity to exploit the machine.
Even the machines understand the upward bias of all markets. So a good trader buys low and sells high. The machines can't beat the house odds. That is the probability wave. Perhaps I can give you a better Quant example.
At ther turn of the century there were 500 auto companies. As of last year only one survived. Could you have picked the winner. Don't be stupid and say yes. The answer is flatly no. But if you had found a way to bet on the automobile industry at large you would have won big. If you had bet indexes long term you would win. Meanwhile the HFT trader is trying to take advantages of the boom and bust of the car companies themselvs and attempting to incrementize the rise and fall of the individual companies. And they are hedgeing all the while managing risk.
By comparison the small investor rarely manages risk. They have the throttle down at all times. But they have a huge advantage in trading slowly and buying down on high quality stocks with lots of liquidity.
I make no secret about it, I like VALE. It pays a huge dividend and owns the global market in Iron ore. Nobody is going to replace VALE and in the future IRON ore demand will sky. Vale is at a 5 year low; pummled by every story about China as if somehow IRON Ore will get cheaper to mine, and become obsoltete. VALE is already the lowest cost producer with 76% of the global market. So how can a machine see this? It doesn't. A machine can't quantify reality in terms of an expanding world or future of emerging markets.
The present situation with KNIGHT is a screaming buy. It is cheap selling at less than $10 with a solid book of $12 per share. Even if there is more idiotic regulation and even if dark pools must identify themselves to trade, KCG is a publicly traded company with books opened to the world. If anything additional regulation will reduce competition to KCG.
Don't get me wrong, I am all for making dark pools identify themselves before trading in US Markets. There are rogue Russian traders with mob money, there is George Soros, a convicted inside trader who trades with impunity in all markets and Martha Stewart who can't trade at all. There is inequity but it is in the enforcement of the existing laws not in the very short interval trading of the HFT machines.
Please forgive me for the typos; I know there are a few but I don't have time today to cut and paste and run spellcheck. Thanks