Debate over whether high-frequency trading (HFT) "rigs" the stock market to the detriment of individual investors intensified Friday as Attorney General Eric Holder announced an investigation into the practice. Author Michael Lewis claims high-speed trading firms get an unfair advantage over regular investors in his latest book "Flash Boys."
On Thursday, Lewis gained an endorsement from Charles Schwab, the investing luminary who founded the firm that bears his name. Schwab and Schwab Corp. CEO Walter Bettinger described HFT in a statement as a "growing cancer that needs to be addressed." They further claim that it is "designed to pick the pockets of legitimate market participants."
But on Wall Street, the debate is far from one-sided. The Modern Markets Initiative, which advocates for high-speed firms, continues to argue that critics overstate the risk and underestimate the benefits of the technology, including lower transaction costs.
"It's not helpful to use broad generalizations that lump the vast amount of good market behavior in with a few bad actors," said Peter Nabicht, a senior advisor to the MMI, in a statement.
In an interview this week with CBS MoneyWatch,Vanguard founder Jack Bogle said he didn't think that HFT hurt individual investors, a view backed up by professors from the Massachusetts Institute of Technology and Cornell University. Nonetheless, Bogle pointed out that stock markets continue to be vulnerable to technological glitches such as the one that caused the "flash crash" a few years ago.
Ed Yardeni, who runs a research firm that caters to institutional investors, also doesn't think that the practice hurts average investors. But he has plenty of concerns about its impact on large, institutional investors.
"I am concerned that for all practical purposes it amounts to front-running," he said in an interview, noting that high-frequency trading firms are able to determine market moves by examining the flow of orders. "They don't expect someone to use that information to move prices. They expect to have their orders executed."
TD Ameritrade, the largest discount brokerage firm measured by client activity, has some concerns about high-frequency trading, but also notes its benefits. "We have seen it lead to greater liquidity and tighter spreads, which helps maintain the stability of the markets, and those are good things for investors," a representative of the firm said, noting some questions from clients about the issue. "That said, there will always be individuals or entities that try to exploit areas of the system, and if they are using HFT to gain preferential access or to take advantage of other market participants, those activities should be addressed and stopped."
Huw Gronow, a senior trader at Principal Global Equities, noted in a blog post that his company tries to avoid the pitfalls associated with high frequency trading outlined by Lewis, such as the advantage they gain by knowing about order volume, a practice dubbed "scalping."
"Every trade creates a signal, and those signals can provide information to other market participants," he writes. "We try to avoid sending obvious signals by employing trading strategies and techniques that can minimize how much of that information gets out."