HFTs, Dark Pools and the markets – harmony or dysfunction?

It just needs to be said that this blatant act of manipulation is running unchecked to the detriment of the share market and the genuine shareholders who invest in the ASX. If a buyer puts a sell order on for 500 shares the Algorithm can sell him one share for say $1.50. The seller then has to pay for the $21.00 cost of the trade to buy a $1.50c share. The algorithm can sell one share at a time and fk the seller. The buyer gets a share that cost him $1.50 plus the cost of the trade another $21.50 so the share actually cost him $23.00 for a $1.50c share. In the case of the ASX no one can stack buy orders or sell orders. In other words its illegal to put say: a bid for shares @ $2.00, ten under that a bid for $1.99 and under that a bid for $1.98 and so on. It is also illegal to do it on the sell side as to effectively cap the market price. Yet an algorithm (coded by humans) can do this. Algorithmic trading allows some market participants to engage in market manipulation. Do Algos provide real improvements in liquidity? There is some evidence for and against… on balance algos/HFT may reduce bid ask spreads for large, liquid stocks but this reduced trading cost could be hard for investors to capture, and there may be no benefit for smaller, less liquid stocks. Are algo-sniffers unethical? They would argue for a symmetry in perspective… the following comes from a very readable article on the flash crash. "I don’t look at it as in any way evil … I don’t think the guy who’s trying to hide the supply-demand imbalance [by using an execution algorithm] is any better a human being than the person trying to discover the true supply-demand. I don’t know why … someone who runs an algo-sniffing strategy is bad … he’s trying to discover the guy who has a million shares [to sell] and the price then should readjust to the fact that there’s a million shares to buy." http://www.lrb.co.uk/v33/n10/donald-mackenzie/how-to-make-money-in-microseconds The Charter of a Stock Exchange is for people to invest in listed companies with the hope of an increase in the share price and the hope of a dividend. Stock Exchanges were a way for companies to raise cash via the public offering riches in the process. With short selling via dark pools and algorithms churning we have groups that are in direct opposition to the Stock Exchange charters. The Shorters are out to send stock down and hope to buy at a lower price. During the GFC all the stock exchanges globally stopped short selling because they said that it was destroying the stock exchanges because they were taking advantage of the downturn in the markets. The problem is that the shorters (major insto's) have unlimited funds to manipulate any companies share price up or down or sideways. ASIC say Shorting adds liquidity to the market. That's their song. In fact it doesn't add any, (zero) liquidity to the market. It adds turnover not liquidity. There is a regulatory rule in ASIC that can allow a company to have their stock exempted from short selling especially when a company is going from explorer to production but in practice this is impossible to obtain. Of course there have been instances of short-sellers engaging in predatory behaviour. But there is a lot of evidence that shorting enables price discovery. If people can't short then the price is set by the marginal buyer. Think of the market for a popular piece of art where there are only 100 prints. The price is set by the 100 people willing/able to pay - if I think it's dreadful I have no way to impact the price. A highly popular stock is just the same if short selling is not allowed - the price is set by the people who want to hold it and there is no way for others to express negative views (other than stock options if available). Recall the TMT boom? A very readable discussion of the topic is given by James Clunie. http://www.harriman-house.com/book/view/111/trading/james-clunie/predatory-trading-and-crowded-exits/ The combination of short selling in algos/HFTs could of course explain flash crash etc. But short selling is not new. The way that algos/HFTs are regulated is the necessary condition for change.