A healthy side effect of high-frequency trading?

HFT robots might just be doing the Lord's work

Day trading
(Image credit: (Spencer Platt/Getty Images))

High-frequency trading (HFT) is nearly universally reviled. The tournament externality is just too obvious; it yields no social value to bring a piece of information to the market one millisecond before it would otherwise have arrived, but people are apparently spending lots of money in an effort to do so. It can't be efficient to commit our best and brightest minds to beating each other to the punch by one millisecond. Because of this, many have suggested a small Tobin tax to curb HFT. Others have suggested batch auctions.

As for me, I've never been that worried about HFT, because I viewed the costs as small. HFT profits have been falling steadily in the few years since the technique became popular, from almost $5 billion in 2009 to just over $1 billion in 2012. Trading volume is down too. And I'm not very scared of flash crashes. So I viewed HFT as a very minor nuisance at worst.

But what about the benefits of HFT? The one usually cited — "providing liquidity" — seems a minor benefit. Minor benefit, minor nuisance. Then there's this interesting paper by Douglas Cumming, Feng Zhan, and Michael Aitken, which suggests that HFT actually drives out market manipulators. Robots defeating sneaky underhanded Wall Street fixers? That sounds good to me! Though of course HFTs can engage in manipulation of their own.

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But when I read this article, I thought of another possible benefit of HFTs. The article, by Eddy Elfenbein (excellent name, btw) at Crossing Wall Street, is about day traders being made obsolete by HFT robots:

I've got bad news for all you day traders out there. Just like assembly-line workers, switchboard operators, copy clerks, and hand weavers before you, you've now been automated out of existence...

What [HFT] means for you is that now more than ever, day trading is a fool's errand. If you were ever tempted to enter the fray, recognize once and for all that those banks of computers chugging away at their algorithms have you hopelessly outclassed. There's simply no way an individual human being can compete against a fleet of CPUs that rivals NASA's. Do not, I repeat, do not try it. You will lose. [Crossing Wall Street]

This gave me a new, positive vision of HFTs. If day traders across America really do believe what Elfenbein is saying, and if they really do stop day-trading and start doing long-term fundamental investing, then the HFT robots are doing the Lord's work.

Why do I say this? Because here's the thing about day traders: Even before HFT, day traders consistently lost money. Actually there is a small number of day traders — maybe 1 percent — who make money day trading. But the rest just lose, and lose, and lose. The evidence is not ambiguous.

As for the reason that human day traders lose money, there are probably several factors. Humans are overconfident. We don't benchmark our performance very well. Mental accounting makes us ignore trading costs (which tend to gobble up whatever profits a day trader thinks he's making, and more). Self-attribution bias makes us think that our gains came from skill and our losses came from luck. The basic fact is: You, a human, make a lousy, lousy HFT algorithm. And if robot HFTs make you realize this fact and quit trying to be a human HFT, then they are doing good for both you and for the world.

Thinking of this, I'm starting to realize why Zero Hedge hates, hates, hates HFTs. With its shirtless Brad Pitt avatar and its tough-guy language, Zero Hedge caters to testosterone-junkies. Testosterone junkies are young overconfident dudes with a little money in their pocket, who maybe work day jobs on Wall Street, or maybe just got their law degrees, or maybe work as engineers and think they'll be the next Steve Jobs, or whatever. Being young, overconfident dudes, they think their intelligence and energy and sheer will-to-power will allow them to take on the world. And when it comes to their finances, taking on the world means beating the market by seat-of-the-pants day trading.

We've all met these guys.

So of course these guys, and the websites that cater to them, despise HFT. Not because it crashes markets, not because it wastes money on pointless "information tournaments," but because it takes away their dreams of outwitting the world and landing that big score.

To which I say: Sorry, dudes. Much as it pains me to say this to anyone, your day-trading dream was always kind of an illusion. You were always just going to eat trading costs and die. Here's my advice: Don't give up on crazy world-conquering dreams, but try to switch to one that creates real value for society instead of just adding noise to financial markets and feeding the coffers of quant funds. Give up the day-trading dream, and focus on being the next Steve Jobs.

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