For many people the stock market was already viewed as a casino and a giant gamble; its systems and processes opaque and nonsensical. The latest firestorm on High Frequency Trading (HFT) has not helped dispute this view. Lately the market has been buzzing with discussion involving Michael Lewis’s latest book Flash Boys which is all about HFT. The book goes so far as suggesting that the market is “rigged” and that individual investors are getting taken advantage of by firms that are making riskless profits. So what exactly is HFT, how does it affect you and does it even matter?

HFT uses high-speed computers to analyse a multitude of market trends and then makes trades on them faster than any human possibly could. The software can buy and sell a stock at speeds 100 times faster than the blink of an eye — profiting a mere fraction of a cent. Add up these pennies in large volumes and large profits can be made. The firms using all this technology have spent billions to gain a millisecond edge and in essence can front-run many types of orders.

Flash Boys goes through three activities that have led to a vast amount of what many consider to be grotesquely unfair trading practices due to HFT proliferation. The first could be called “electronic front-running” — seeing an investor trying to do something in one place and racing him to the next based on speed.

The second relates to “rebate arbitrage” — using the new complexity to game the system by seizing whatever kickbacks a stock exchange offered without actually providing the liquidity that the kickback was presumably meant to entice.

Finally, and probably by far the most widespread, is referred to as “slow market arbitrage”. This occurred when a high-frequency trader was able to see the price of a stock move on one exchange, and pick off orders sitting on other exchanges, before the exchanges were able to react to the difference.

Say, for instance, the market for Bank of America shares is $19.00 — $19.01, and buyers and sellers sit on both sides on all of the exchanges. A big seller comes in on the NYSE and knocks the price down to $18.98 — $18.99. High-frequency traders buy on NYSE at $18.99 and sell on all the other exchanges at $19.00, before the market officially changes. This process goes on every day and tends to generate billions of dollars a year more than the other strategies combined. All three predatory strategies depend on speed or what is commonly referred to as “latency arbitrage”.

But does all this matter? For the little guy, not so much. HFT is not focusing on your Microsoft buy order. For the large institutions, of course, every penny taken on a trade adds up since hundred thousand share orders are the norm. HFT front running drives the trade price higher increasing the cost to the investor. Therefore the cost can run into the hundreds of millions and they are probably rightfully upset and concerned. This may impact the mutual fund that you own by lowering the return by a couple percentage points over time.

However, it may not mean much going forward because the market, as it usually does, is taking care of this. The HFT arms race has ground profits down for all firms as the competition has heated up. TAAB Group expects HFT revenue from US equity trading to be just $1.3 billion this year, compared with more than $7 billion in 2009, and the HFT share of market volume today is less than 50 percent, after being as high as 70 percent a few years ago. Also Brad Katsuyama, the hero of Flash Boys, with IEX, his new exchange, is developing an option for those wishing to have HFT’s effect on their trading neutralised. It isn’t necessary to eliminate high-frequency traders; all you need to do is eliminate the unfair advantages they have gained by speed and complexity. It is important to repeat that the market is dealing with this — not the government or regulators. It simply took competition and someone with a moral compass to step in and solve the problem.

All of this debate and conjecture could ultimately be hurting the public good in a few ways:

1. It seems to me that a colossal amount of talent continues to be funnelled into the finance industry doing many things that ultimately do not advance the general public good in any significant way. All those extremely smart computer programmers could be used to optimise biological compound models or develop software to solve some of the world’s other problems instead of spending countless hours and brain power building systems that simply skim pennies.

2. Six years after the financial crisis, most Americans still remain unwilling to take risk in the stock market. According to recent research by Bankrate.com, 73 percent of those surveyed are not investing. Furthermore, according to a survey conducted by ConvergEx Group LLC, which provides brokerage and trading-related services, two-thirds of financial industry participants, say the US equity markets aren’t fair for all. Just over half, also said HFT is harmful or very harmful. The accusations being slung around that the market is “rigged” and unfair due to HFT trading doesn’t help investor confidence. In fact, an overly sceptical and extremely conservative investment stance is compounding the retirement crisis because many Americans (Bermudians too) have not saved enough for long-term goals like retirement. If they continue to avoid the market and eschew risk it will become increasingly difficult for them to have any chance of a well-funded retirement. Confidence is a key factor if not the most important factor to having a well-functioning market.

3. Complexity breeds fragility. Immensely complex systems tend to be more prone to breaking with catastrophic consequences. The US market has become much more complex, with 13 exchanges, around 45 private dark pools, or alternative trading systems (ATS), and as many as 200 firms that internalise their orders, which means the broker matches the trade inside the firm. This complexity simply creates a greater risk of something going horribly wrong. As Lewis states in the book: “The price volatility within each trading day in the US stock market between 2010 and 2013 was nearly 40 percent higher than the volatility between 2004 and 2006, for instance. There were days in 2011 in which volatility was higher than in the most volatile days of the dot-com bubble.” It’s unclear if this is directly due to HFT but I suspect that is has some influence in this regard.

Speed is not a problem and “making markets” is not a problem — these factors have always been important in markets. The US equity market is far more efficient than it was 30 years ago and is still one of the most efficient markets for any asset class in the World.

The liquidity that HFT portends to provide is probably overrated as electronic trading itself has probably offered more benefit on the margin than HFT. Besides, liquidity is like ice cream on a hot day — you want some but you don’t really need a freezer full if you are a true “investor”. Unfortunately the market will always have groups of people who try to game the system. This has always been the case. What is refreshing to see, in this case, is a man like Brad Katsuyama risk his career to level the playing field for investors if they so choose. Will he make money in doing so? Of course, and he should.

Nathan Kowalski is the chief financial officer of Anchor Investment Management Ltd (www.anchor.bm). The views expressed are his own.

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