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Tuesday, October 13, 2009

Using High Frequency Trading as a Scapegoat Has Jumped the Shark

Matthew Goldstein at Reuters wrote an article about what can go wrong when investors use stop-loss orders. A stop loss order is an order to sell your stock when it reaches a certain level to the downside - ie, if GE is trading at $16, and you want to lock in profits if it starts to fall, you can enter a stop-loss order to sell at $15. Then, if GE hits $15, your order will be entered into the marketplace. The catch is that if GE is plummeting and there isn't a lot of liquidity, you could sell your stock much lower than $15.

So, Goldstein describes a few investors who didn't understand that their stop-loss order doesn't guarantee them execution at their stop price. They were trading a lightening fast moving highly speculative biotech stock called Dendreon, around the time that Dendreon had news imminent regarding a potential cancer treatment drug. The stock started to fall, stop loss orders were triggered, stock was sold at a low price, and the stock quickly rebounded.

There are two real stories here: one is that the stock may have plummeted because a trader entered a "fat fingers" order in error - perhaps typing an extra zero onto the end of the order, and the other story is that someone intentionally may have leaked misleading information about the drug trial results in order to manipulate the stock. There's actually another story, and that's the danger of "market" orders, and how investors should never used them. Goldstein, however, decided to jump on the populist bandwagon, and blame high frequency trading for the price action in Dendreon's shares. He even titled his post "The Victims of High Frequency Trading." Talk about jumping the shark!

Goldstein's hack piece prompted Zero Hedge to write a post titled "Was HFT Responsible For Investor's Massive Dendreon Losses?" I think that even the guys at Zero Hedge know that the answer is "no," but they are in the business of generating page views, hence, the post.

I'm going to address some other concerns that the uninitiated may have about damage done by high frequency trading (HFT):

Did HFT kill Michael Jackson? NO

Did HFT cause the breakup between Jon & Kate Gosselin? NO

Was HFT responsible for Obama winning the Nobel Peace Prize? NO

Did HFT get Kourtney Karsdashian pregnant? NO

Is HFT helping Osama Bin Laden hide in the mountains of Afghanistan? NO

Did Jonathan Paplebon allow 3 ninth inning runs on Sunday against the Angels, resulting in the end of the season for the Boston Red Sox because of HFT? NO

Can HFT spread swine flu (H1N1) ? NO

Could HFT beat George St. Pierre in the octagon? NO

Can the dominance of the NY Yankees be explained by HFT? NO

Did HFT cause the tsunami in Samoa? NO

Did HFT help Iran obtain nuclear facilities? NO

Does HFT hate health care reform? NO

Put. Down. The. Pitchforks.

-KD



4 comments:

TraderPsyches said...

Love it!

And realize that if you ban HFT, at what time interval do you stop? 1 day? 1 hour? 10 minutes? 1 minute? 30 seconds?

...or just a tax on trading?

Anonymous said...

I held some DNDN calls at the time and was browsing the Y! finance boards the morning of the crash. Some anonymous user posted that there would be a "bear raid" at 12:30. He was just just 3 minutes off when the stock fell from 23 to 8, rebounded to 12 and then halted. Not sure if it was HFT or just market maker collusion, but that was definitely not normal trading.

Kid Dynamite said...

anon - that's an excellent example of potential stock manipulation, but is almost certainly completely unrelated to HFT, since HFT algo's do not go on YHOO message boards and pre-announce manipulation like that

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