For all of its influence over the short term, price discovery of an array of asset classes and notable the precious metals, High Frequency Trading (HFT) fuels an even more ominous trend. The speed and widespread use of trading algorithms have expanded the gap between fundamentals further than anyone could have imagined.
Quote spreads are much wider and less stable during market open, which causes many micro flash crashes in individual stocks.
We see this in daily movements, up and down.
Daily movements like this, with unexplainable volatility to create misleading price quotes, interferes with price discovery - one of the core functions of commodity price discovery.
This leads to a relative false sense of economic strength or weakness. And hence, sentiment is drawn into a fantasy, further distorting opportunity and causing misallocation of personal capital (or at least conservation of purchasing power).
Mis-allocation of Resources - Both Human and Technological
The growth in HFT has created a zero sum game where the technology required to compete in these markets is bid up to prices well outside the majority of average traders. This rise in technology cost and capacity moves exponentially, while the information needed or transmitted plateaus.
Trading becomes further and further detached from reality and out of reach by a heterogeneous base of players.
Like any noise in the system, the quote spam generated by these machines obscures nearly completely any chance of piecing together the cause of damage, This leaves regulators neutered and, thus, dependent on the rotation of insiders to have any hope of reigning in these systems.
Price Discovery Damaged Beyond Repair
Precious metals paper price discovery was already damaged, but the rise of the machines has made the damage more complete. This situation nearly assures that the mechanism will break completely at some point, causing widespread damage as investors suddenly awaken to fair value all at once.
Almost every week flash crashes in both gold and silver have occurred at the open, induced by huge fill or kill orders. This pushes prices down suddenly, and triggers more selling. The banks who engineer these crashes are always there to pick up the entrails left behind, while the media and the rest of the professional trading community paints a new chart pattern and position accordingly.
According to Erik Hunsader of the data stream and trading consultancy NANEX, HFT generated so much quote spam in the flash crash of May 2010 that it took five months for the SEC to assemble the data.
HFT Crowding Out Trade Protection Mechanisms
Furthermore, according to Hunsader, investors are now being warned against using market orders and stops because HFT can and will suddenly withdraw their quotes. This alone should tell you something is rotten at the core.
During the flash crash, excessive quotes from HFTs overloaded quote data feeds, causing severe delays. Stock quotes from some exchanges were behind over 30 seconds during the height of the flash crash.
HFT Crowding Out
Hunsader notes that, "Investors are warned against using market orders and stops because HFT can and will suddenly withdraw their quotes. This alone should tell you something is rotten at the core."
Furthermore, the massive increase in price quotes via HFT has made the data prohibitively expensive, crowding out academia along the media from access to the trade mechanisms. Dark pools are literal in the sense.
Fuels for the Fire
While any form of manipulation ultimately ends badly, the complete loss of natural market randomness creates an even more fragile situation and a much worse outcome for all.
HFT has become the unnatural expansion in a long list of financial analogies created in the aftermath of decades-worth of financializations. The return to fair price equilibrium as a result of the next big flash crash will be a storm that most will not be prepared for. Allocating some part of a personal investment portfolio to the tangible and encumbered has a proven track record of anchoring before the storm.