Blogs & Comment

Journalists vs. high-frequency traders

Some market watchers and politicians are blaming the world's woes on the press and high-frequency trading, but they're just shooting the messenger.

Today isn’t a great day to be a professional market watcher or news reporter. We are under attack on two fronts.

First, there is the journalism licensing scheme that was just proposed by British Labour Party shadow minister Ivan Lewis, who wants some authoritarian body to be able to ban people from the profession for malpractice. (Oops, I mean he “reportedly” wants to do that. I’ve never talked to the man, so I must be careful in order not to risk being blacklisted, especially since I recently wrote about why the U.K. is doomed.)

A similar proposal has been floated by Quebec Culture Minister Christine St-Pierre.

Now, it is true that journalists often fail to act like professionals. Some succumb to pressure to sensationalize stories to boost sales. Others have been known to make stuff up just to get noticed. But as noted by Tom Chivers, assistant comment editor at Britain’s Telegraph, “the idea of a journalists’ register is preposterous,” especially in a world of tweets and blogs. Would U.K. Labour Party blogger Tom Watson (no relation to me, although I like his name) have to get a permit?

The other attack on my profession hits closer to home. Indeed, business journalists are being blamed for the dramatic rise in stock market volatility. And believe it or not, the accuser is a member of the controversial high frequency trading set.

HFT has come under fire in recent years because it is a relatively new and complex strategy that is growing fast despite having little to do with the performance of publicly listed companies. Simply put, profits are generated via supersonic buying and selling controlled by computers that take advantage of short-term opportunities created by the fragmented markets, not to mention the orders placed by slower and long-term players.

Critics insist HFT distorts pricing signals sent by investors who support the capital raising activities of the economy. Supporters insist the volume of trades that HFT shops provide generates a steady flow of awesome liquidity, giving Adam Smith’s invisible hand a bionic upgrade by making it better, stronger and faster like Steve Austin in the Six Million Dollar Man (look it up here, kids). I wrote about HFT in Canadian Business earlier this year. You can read that article here.

Anyway, on Sept. 11, the New York Times published an article that noted the increasing frequency of extreme market gyrations has regulators “looking at changes in the markets and automated trading strategies.” This prompted a response by Manoj Narang, CEO of Tradeworx, a financial technology and HFT trading firm.

In a guest post in The High Frequency Trading Review, Narang freely admits that “there has been an increasing incidence, in recent times, of days exhibiting unusually high volatility (measured as days when the close-to-close return, or alternatively, the high-low trading range are large in magnitude).” But he insisted the data used by the NYT’s story also reveals “that computerized trading (in particular, high-frequency trading), bears absolutely none of the culpability for this.

Narang notes volatility has increased more in non-trading hours than during the trading day. From 2000 to 2006, he points out, the S&P 500 moved an average of 0.37% per day when the market was closed, meaning between the close of one day and the open of the next. Since then, it has moved an average of 0.61% per day after hours, a 65% increase. And Narang insists it is impossible to blame high-frequency traders for this rise “because there is no trading when the market is closed.” This volatility reflects one thing and one thing only, he says, adding that “markets react to news, and since 2007, there has been an abundance of news which has caused investors to panic.”

So there you have it. Journalists and social media practitioners, not members of the HFT gang, are the culprits because we report bad news to humans. “Volatility is caused by panic behavior,” Narang says. “Computers don’t panic, humans do.”

Now, I see real problems with this logic, and not just because my favourite Star Trek episode is the one with Nomad, the computerized probe that panics and blows itself up after learning it is imperfect, like human traders.

Market volatility stems from dramatic changes in bid and ask market orders. And according to the data that I have seen, high-frequency computers dominate trading on today’s exchanges, so they must be playing some role in the close-to-open volatility.

Some automated trading systems operate in the off hours, deploying algorithms that guesstimate the overnight changes in market sentiment by analyzing news sites and investor blogs. I can even try to do that myself using an iPhone app called Wall Street Scanner, which I wrote about here

It is clearly possible that super fast trading programs feeding off the panic of humans are responsible for a major portion of the volatility we see in markets today. So don’t blame the messengers.