With Robert Karofsky, Global Head Equity Trading, AllianceBernstein
We use dark pools significantly. I think dark volume as a percentage of overall volume is close to 35%, and we’re not exceptional in that. There’s less leakage in dark pools as we’re not exposing our orders to abuse. It doesn’t mean that dark pools are evil, it just means that there’s information leakage in the lit and we need to use a combination of all these tools to trade. The best and most sophisticated buy-side trading shops, of which we believe we are one, set nothing in stone.
You start trading and you learn throughout the day. If you don’t find natural liquidity, you trade quietly. Maybe you trade anonymously, you’re trading electronically, you’re probing, you’re exposing your orders to dark venues and sometimes you just get out of the market altogether. The best way to trade without impact is to be unpredictable and anonymous and that’s what we try to do. We try to be unpredictable, we try not to leave our footprints and so that means doing things differently every day.
Do you think more firms are starting to realise just how important the trading is as an integral part of the overall investment process, or do you think there will always be firms adopting a more fundamental approach?
I think that it depends. Some PMs think that they own the alpha: they press the button and they decide where they want to get in and get out. We know it couldn’t be further from the truth. I think that the one benefit from all of the noise around high frequency trading and Michael Lewis’s book, is it raises the subject of trading, and it lets people know how complex it is.
Connecting and navigating all this with terminology in microseconds and microwave technology is daunting; it’s not easy and trading is extraordinarily important. You can look at it two ways: adding alpha or protecting alpha. For me there’s no difference; greater collaboration and coordination between the trading desks and the PM’s and analysts pays enormous dividends. There are a lot of firms that look at it this way and I think those are the most successful firms.
If you don’t know where your orders are being executed and if you’re not monitoring accelerated venues and sell-sides, then you’re behind the times and you are obviously making yourself vulnerable to the predators in the market place. That’s why we have invested in our own quantitative trading team and they are constantly evaluating and monitoring these variables and making us highly effective in the market place.
There are problems in the marketplace though, and I think instead of saying the market’s rigged, it is better to say that there are problems with the market; you have multiple, different economic schemes at different exchanges, and you’ve got multiple order types at various exchanges, which create an environment where some people can have an advantage over others. It’s not always the case but it’s certainly a less than perfect marketplace; there are areas to improve and we should all be striving to reach that. This is not to say the market is rigged; there have always been people that have had advantages versus other folks and that’s never changed.
High frequency trading and electronic market making is just an extension or technological evolution of upstairs market making and specialists. We were at a much greater disadvantage under that regime; trading on a stock exchange with specialists who could see the order book at all times. We had one place to trade and they saw the whole picture and nobody else did, and they had their purpose. They had a lot more information than other people and they were a for-profit organisation. So why can’t electronic market makers also make a profit? The way they make profits is by very quickly sizing up supply and demand and taking advantage of that, and buying low and selling high; that’s the way it’s always been done.
It happens, but it’s always been happening. If I am working an order with Merrill Lynch and Morgan Stanley calls me and says they’re a buyer of the same stock that I’m trying to buy with another firm, I call that firm and get more aggressive. So that happens within 30 seconds but what is the difference? People are using information to their advantage.
It’s not a perfect system but the question is, what makes a perfect system? If you get rid of high frequency trading by doing certain things, then we go from 6 billion shares traded a day to maybe 3 billion. Is that good for people? You can ask is volume liquidity, or is liquidity volume? I don’t think anyone really knows the answer to that, but it’s somewhere in between so we need to be careful. Saying something is evil and needs to be carved out of the system is too much. There are some subtle things that can help level the playing field to all participants, but we don’t want to do something that makes people leave. We have got to be very careful to reiterate, trading costs are lower than they’ve ever been – isn’t that the most important thing?
How much is regulation being reactionary to populist sentiment?
There are things that can always be improved but you have got to be careful. Look at the use of steroids in baseball; the regulator called this into question and now the integrity of the entire sport is in a mess. The attack levied by the governing body almost backfired – they could have just tried to control the situation more subtley. If a system basically works, we need to accept that there are always going to be people that use the current environment to their advantage at the expense of others. This is never going to change.
The irony of the current situation is that everybody, including myself, had to Google what’s faster, a millisecond or a microsecond. Who does this really impact? I do agree that there are predators in the market, and some of the high frequency firms are predators. They arbitrage, they exploit the difference in data feeds between the direct exchange feed and the consolidated tape and those things aren’t good, but I do believe that it is often just one high frequency firm versus another. If you look at profits by high frequency in trading firms, they have significantly decreased over the years. It’s a fraction of what it was.
We have built-in systems that tell us when we’re getting gamed, when fill rates aren’t working; when people are running in front of us, we know this. If high frequency firms are speeding up, one positive consequence of that is we’re getting our signals faster as well. It doesn’t work the other way. If somebody’s scalping you for a penny, it doesn’t matter if they’re scalping you for a penny quickly or slowly.
With Robert Karofsky, Global Head Equity Trading, AllianceBernstein