SERVING ALL, NOT JUST THE ELITE FEW
- Trading today is mostly computerized scalping done under a sanitized name – "market making." It is armed and encouraged by for-profit stock exchanges, which make their money catering to these high-frequency traders, by selling them on-site servers (for speed), providing them with data feeds (for order identification and modeling), and attracting their volume through a payment-for-order-flow pricing model known as "maker-taker," in which orders that supply liquidity to the exchange get a rebate on fees, while orders that take liquidity get charged fees.
Liquidity is no longer based on supply and demand, but on a high-speed video game of manipulation.
This model has encouraged huge spending on software and hardware development to maximize the generation of rebates for high-frequency traders. As a result, the foundation for liquidity and pricing stocks has changed dramatically. It is no longer based on supply and demand, but on a high-speed video game of manipulating and getting in between retail and institutional orders in order to generate rebates. Amazingly, all of this has been aided and abetted by the Securities and Exchange Commission through regulations intended to improve competition.
And how have we benefited? Retail commissions have dropped to $8 from $20 per trade and institutional commissions have plummeted to a penny per share, but spreads have barely declined since 2006. Moreover, the trading arms race has resulted in jaw-dropping volatility and systematic risk, scaring a generation of investors from the market. Just look at the financial crisis of September 2008, the flash crash of 2010, flubbed I.P.O.’s (like BATS and Facebook this year), and last week’s "Knightmare," when a Knight Capital software glitch resulted in huge volume and price volatility on the New York Stock Exchange for 45 minutes.
Investors should insist that regulators fix the system, not by tinkering at the margin or "monitoring," but by rebuilding the foundation of the markets. We recommend they start by banning payment-for-order-flow at all levels, from retail brokers selling investors’ orders to wholesalers, to banning the maker-taker model on exchanges. When this clean-up is complete, we can look forward to sensible and low-cost trading, in which technology is used to increase efficiency and productivity for all participants, rather than provide the privileged few with unfair advantage at the risk of destabilizing the system.
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