Haim Bodek, Decimus Capital
"The reality is that many of these practices, which were represented as secret sauce, were really just a broken vending machine. You hit it the right way and coins came out."
Haim Bodek, founder of Decimus Capital, talks to Automated Trader Editor Adam Cox about his campaign to shed light on the relationship between exchanges and a number of HFT firms. Along the way, he also talks about prospects for a return to more quant-oriented strategies and the implications of a volatility regime change.
Adam: You've been trying to draw attention to a lot of practices you think are unfair, even if some are, strictly speaking, legal. How much of an impact do you think you're having?
Haim: Prior to me alerting people to the crucial intersection between HFT profitability and HFT-oriented special order types at the exchanges, that interaction was not quoted on in any manner by the press. And now it's on the front page of many trade journals and it's been raised at a number of Senate Congressional hearings as well as the investigation of special order types which has been going on 18 months. In November of 2012, the SEC Office of Compliance Inspections and Examinations also launched a rigorous probe, which was expected to last a year, on the issue. On top of that you've got a number of structural changes at the exchanges. I don't want to go into details on what's changed - it's an ongoing investigation -- but I would say that of all exchanges, I've been particularly impressed with how proactive NASDAQ has been to disclose their functionality and also modify their functionality.
Adam: You're not talking about getting rid of HFT. You're talking about eliminating some advantages that HFT firms have had.
Haim: I think there's a theme here. I came from an algorithmic trading background, really a hybrid between microstructure technology-oriented trading and quantitative trading. What you see in HFT is the abandonment of the more quantitative traditions. And you see it focusing on exploiting loopholes. So I found the entire practice, once I got exposed to it, as being intellectually brain-dead. It's kind of an inside joke as to how brain-dead the strategies are. The reality is that many of these practices, which were represented as secret sauce, were really just a broken vending machine. You hit it the right way and coins came out. So I alerted regulators to the practices and I'm just watching to see how it unfolds.
Adam: There are plenty of studies that suggest HFT has brought down spreads. Do you feel there are some benefits to HFT?
Haim: I don't see anything inherently wrong with HFT trading concepts. The concepts make sense. I make a distinction. When I use the term HFT, I'm referring to the specific firms that got unnaturally large by playing specific strategies that exploited loopholes. And what you're talking about is the general tradition of HFT that has spanned the last 10 years. I would argue the term HFT didn't come into play in the greater financial community, or at least it wasn't a buzzword, until these specific firms which came out of nowhere became very profitable in a short amount of time, marketing themselves as being the next big thing.
Inherently, I have no problem with high frequency trading concepts. I have a big problem with undocumented loopholes at exchanges that are exploited to supercharge particular firms' trading profits.
Adam: Being a devil's advocate, if you're an HFT firm and the loophole is there, why wouldn't you exploit it? From your point of view is it more the exchanges that need to reform?
Haim: The issue here is that the features that I'm most concerned about were developed between exchanges and specific trading firms in a non-public manner. It's the features of the special order types, the specific conditions which are vital for these HFT strategies. One criticism that is now public is the queue jumping phenomena, which is a violation of price and time priority. That type of queue jumping behaviour is completely and absolutely unsubstantiated by any regulatory filing.
What HFTs know and what the rest of the world doesn't know, is that queue jumping is a feature that was requested: 'I'm not bringing orders to this particular exchange unless I can have this priority.' It really should be in the documentation.
Adam: Here you're referring to the practice of using hide-and-light orders, which you've talked about before.
Haim: Let me be very explicit here. NASDAQ rolled out a new version of hide and light which had specific prohibitions against queue jumping. So a hide-and-light order does not need that perk. That perk is hugely important, and it is undocumented on a number of exchanges.