High-frequency trading has spawned a plethora of conflicting viewpoints. For critics of the practice, HFT firms are predators that exploit technology to cheat the competitions and game the system. To defenders like Mark Gorton of Tower Research Capital, HFT is an inevitable and hardly surprising march of technological progress.
For the 48-year-old founder of Lime Brokerage and Tower Research, the proprietary trading shop that he runs to manage his money, HFT not only provides much-needed liquidity, but it has also made the entire market more fair to all participants.
“It’s the most leveled playing field ever, and people should really be happy about that,” he said.
But a lot of people aren’t happy about high-frequency trading. Last spring saw the release of “Flash Boys” by Michael Lewis, the best seller that alleges that HFT firms like Gorton’s are not creating a level playing field, to say the least. There have been calls from attorney generals like New York’s Eric Schneiderman that HFT practices must be examined, and SEC Chair Mary Jo White has singled out HFT methods along with dark pools and algorithms as methods that need to be studied. In a June 5 speech, White told the audience at the Sandler O’Neill & Partners Global Exchange and Brokerage Conference that the SEC had numerous regulatory proposals on the drawing board, including rules aimed at HFT firms. “The SEC should not roll back the technology clock or prohibit algorithmic trading, but we are assessing the extent to which specific elements of the computer-driven trading environment may be working against investors rather than for them,” she told her Manhattan audience. She added, “An area of particular focus is the use of aggressive, destabilizing trading strategies in vulnerable market conditions, when they could most seriously exacerbate price volatility.”
Gorton is not back away from these allegations. While some HFT firms have backed down ? at press time, the co-founder of Tradeworx, Manoj Narang, announced that he was leaving his Red Bank, N.J., HFT firm to pursue other opportunities – Gorton joined with other HFT firms to state their case. Under the banner of the Modern Markets Initiative advocacy group, Gorton’s Tower Research, along with Hudson River Trading, Global Trading Systems and Quantlab Financial, are aiming to improve HFT’s image after the drubbing the sector has taken in the pages of “Flash Boys.”
For Gorton, HFT is technological progress and innovation, pure and simple.
Thanks to his background as an electrical engineer, including a brief tenure at defense contractor Martin Marietta in the 1990s, Gorton naturally looks at the markets in more quantitative ways, he said.
“It’s not like computerized trading was new in the late ’90s,” he said. “You go back and you have the DOT system and the SuperDOT. People have been doing this [for a long time]. It’s been an evolving process. Basically it’s certainly accelerated and gotten more and more automated. There was already, to some extent, an established computerized trading world out there when I got started.”
And high-frequency trading adds value without hurting the markets, according to Gorton. “HFT provides a necessary function in the markets,” he said, pointing to the legacy of what he called “professional middlemen ? the broker-dealers on the trading floors who made sure the markets were functioning well.”
Before HFT and automation, specialists and floor traders ensured the markets were running smoothly. Gorton even cited the traders and speculators who gathered under the famed Buttonwood Tree in southern Manhattan early in America’s financial history. “But now you have customers and investors who come at different times looking to buy and sell, and they want to find that there’s a market that provides good prices continuously,” he said. “You need to have professional traders to do that.”
Gorton drew a straight line from those days to today’s innovative and modern markets. “What you’ve seen over the past decade is that this function has been played for generations by individuals and manual traders, and it has now become more and more automated. As a result of that automation, the trading costs have come down radically, and you now have the markets at the cheapest trade that they’ve ever been. Both small and large investors are saving billions of dollars every year due to the new electronic market structure and high-frequency trading.”
Bad Image Persists
But HFT’s bad image persists, in no short measure due to the misinformation of critics and regulators, according to Gorton. Even a critic of HFT methods and firms will admit that HFTs are on the same level as dark pools in the minds of the public that pays attention to such matters. HFT firms have been bracing for new regulation since the Flash Boys firestorm, and some high-speed firms are even trying to hide what they do. A press relations person from a major HFT firm asked Traders not to describe it as an HFT firm in a recent op-ed, even though the firm described itself as such on its Website.
Gorton is a true HFT believer. And he thinks that HFTs are not the dangerous threat that Lewis alleges in the pages of “Flash Boys,” as well as in the 60 Minutes segment that echoed Lewis’ charges and those of former Royal Bank of Canada trader and subsequent IEX founder Brad Katsuyama.
“Michael Lewis loves to throw around the word ‘predator.’ Trading is not predation; it’s trading,” Gorton told Traders. “If someone puts an order in the market and you execute against that order, that’s just trading. Just by throwing around a lot of inflammatory language and playing very loose with the facts and telling a real one-sided story, Michael Lewis managed to seem like he somehow discovered this pit of evil in Wall Street, which is just not there.”
It has taken a toll on HFT’s overall reputation, Gorton pointed out: “As a result, you have this firestorm of publicity, and I think it really serve to damage the markets because there is this lack of understanding.”
According to Gorton, it’s a case of critics attacking an imperfect market structure. “I’m not claiming that the markets are perfect and that there’s not room for improvement. There obviously is,” he said. “But what you have is this really fairly small problem with the markets, many of which are getting resolved in the course of business [but] that people have chosen to focus on and have really lost sight of the much larger context, which is really what matters.” He added that this has caused a “huge amount of misinformation” and a misperception of the value that high-frequency trading brings to in the market.
When asked about the instance in “Flash Boys” where then-RBC head trader Katsuyama noticed that at the exact instant he executed a trade, the price of the stock he had followed seconds before had increased dramatically, Gorton does not waver in his defense. It’s the fault of RBC and its systems, he said, not the fault of HFTs like Tower Research Capital.
“Certainly markets are places where, if any investor is not careful about how he execute a trade, there are lots of people out there looking for easy money and they can take advantage of that,” he said.
When challenged that RBC was not exactly known for trading sloppily, Gorton pushed back.
“But if you look at what they’re talking about, they absolutely did,” Gorton said. “Over the past decade or so there’s been this shift in trading from manual to electronic. All of a sudden you have to care about electronic routing of orders and make sure it’s done in a smart way.
He added that RBC “didn’t have a clue” as to how its orders were being routed, as described in the Lewis book. “As a result of their cluelessness, people who understood the markets better were able to perceive their intentions before their orders got routed completely. The Royal Bank of Canada did end up having to pay up because they were executing in such a sloppy way.”
As Gorton read Lewis’ book, Katsuyama and his team examined their situation and solved the problem immediately. Katsuyama said that RBC’s telecom networks were subpar and that the orders were getting to the data centers in the wrong order. With the help of a programmer, Katsuyama and his team fixed the problem in two days and made sure their “orders end up at the final destinations at the same time.”
And others followed suit. “What you have is not just Royal Bank of Canada but a lot of people who are supposedly smart financial professionals who didn’t understand the electronic market structure, and as a result their trade execution was not as good as it could be,” Gorton concluded.
According to Gorton, any potential HFT imbalance has been solved since the days of the financial collapse. “I think Michael Lewis is writing about this problem from 2008. I think almost every firm on The Street learned to solve this problem over time,” he said.
Over-Correcting HFT
Critics of HFT practices have called for a variety of new rules and possible solutions, ranging from a charge for every canceled order to a hold period where a trader must hold a purchased stock for several seconds before selling it. As can be expected, Gorton sees these measures as not only an attack on HFT innovation but a quaint attempt to turn back the clock and the progress of the markets.
“You have a lot of people basically saying, let’s get rid of automation and let’s go back to the good old days. Well, the good old days were the days where the specialists on the New York Stock Exchange were making a fortune and Richard Grasso was paying himself $170 million a year,” he said, referring to the former chairman and CEO of the NYSE. “There’s somehow this kind of mythical utopia of the past where markets were perfect, the markets were benign, and Grandma could come and trade just as well as the best hedge fund in the world. That world never existed.”
Gorton represents the new breed of trader in today’s capital markets. Raised in New Jersey, he studied electrical engineering at Yale and Stamford and earned his M.B.A. at Harvard. He started his career at Martin Marietta, which is now Lockheed Martin, and left to work on the fixed income desk at First Boston before its merger with Credit Suisse. He eventually spent four years in the investment firm’s proprietary trading arm before leaving to work on a variety of startups that helped to fuel the Internet explosion of the late 1990s. He founded LimeWire, the peer-to-peer file sharing program based on the Java programming platform. During this heady time, Gorton founded Lime Brokerage as “advanced trading technologies providing systematic traders and institutions access to superior liquidity and access to the most automated, high-volume electronic trading markets,” according to the firm’s Website. It was sold to Wedbush Securities in 2011.
Unlike other prop shops that have fewer than a dozen employees, Tower Research Capital has scale. It employs 440 employees with offices in San Francisco, London, Singapore, Hong Kong, Prague, and in Gorgon, India, outside of Delhi. His New York office, where roughly 250 employees work, is not your usual open array of traders in skinny suits staring at multiple screens. It’s been described as a “cool dorm room” by associates, and it’s Gorton’s way of creating a creative environment, much like his startups days in the Clinton era.
“It’s partially me, but it’s also partially the nature of what we do. The large majority of people that work at Tower are computer programmers or engineers, or have some sort of math or science background,” he said. “We’re hiring from the same pool of people that Google’s hiring from. We’re not really hiring from the same pool of people as most investment managers.”
As the married father of three girls and a boy who range in age from 7 to 11, Gorton credits his daily six-mile bike ride along the Hudson River to his office with getting him ready for his quantitative trading day. “It’s way more pleasant biking along the Hudson than taking the subway. When I get to work, I’m sharper and ready to go after I ride my bike.”
After all, high-frequency trading never slows down.
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