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Weekend Coverage: Q&A With Themis Trading's Joe Saluzzi and Sal Arnuk


Themis Trading heads reveal the lethal triple punch combo that rigs the high frequency trading game, plus other trading secrets.

MINYANVILLE ORIGINAL Joe Saluzzi and Sal Arnuk are the co-heads of Themis Trading, "an independent, no-conflict, institutional agency brokerage firm specializing in equities." They recently co-authored Broken Markets: How High Frequency Trading and Predatory Practices on Wall Street are Destroying Investor Confidence and Your Portfolio. Joe and Sal are the go-to sources for anything and everything related to high-frequency trading.

Adam Warner for Minyanville: As best I understand high frequency trading (or HFT), it relies on the rebates traders get for providing liquidity, enabling them to profit on even scratch trades. And there's no public disclosure of how they allot said rebates. Even Las Vegas casinos don't get this kind of edge; they break even on pushes. So it seems like if there was any desire to actually rein in HFT, the SEC could simply either eliminate these sorts of rebates or at least force public disclosures. Is it that simple?

Joe Saluzzi and Sal Arnuk: Actually, it's not that simple. A lethal triple punch combo is what rigs the game daily. 1) Rebate maker/taker model, which makes the market a giant front-run video game that is designed to max rebates. 2) Insane order types like ALO (add-liquidity only) and Hide-Not-Slide are designed to only help rebate monkeys. Traditional limit orders not only are always back of the line but they stick out as easy marks like a NYC tourist wearing a fanny pack walking around in East New York. 3) And of course, high tech and very expensive colocation arrangements.

The maker/taker model has distorted the price discovery process. It is basically a payment for an order flow system that should be eliminated. And can you imagine exchanges inventing orders where a buy order at $.50 doesn't trade with a sell order at $.50? Those order types have no place in a stock market but exist today.

MV: The flash crash is now a distant memory, and if (when) it happens again, we'll go through another cycle of hearings and fake outrage. Has anything meaningful actually changed in the last two years?

JS and SA: The SEC banned "naked" access, eliminated "stub quotes," and installed single stock circuit breakers (which will be converted to limit up/limit down mechanism next year). These are all Band-Aids placed on a wound that is still infected. The real issue is that the SEC has proposed some more meaningful reforms over the past few years to deal with dark pools and flash orders, but they have yet to get them approved. The SEC has also proposed a more robust monitoring system, which could detect manipulation called the Consolidated Audit Trail. Unfortunately, this, too, is stuck in review.

MV: On some level, I knew turning exchanges from quasi-public service and member owned institutions to for-profit enterprises was a very bad idea. It would simply distort the priorities. Then again, my background was as a market maker, so it was pretty clear that move would sell out the locals at the expense of some future shareholders. But I can't honestly say I foresaw anything like the algo-dominated world you lay out so well in your book, Broken Markets. Are we here today if the exchanges never go for-profit, or was HFT of this magnitude an inevitability?

JS and SA: Hard to say. For-profit exchanges [are] a disaster, no doubt. They said they had to become for-profit to compete globally. That's ridiculous. By converting to for-profit (and even worse, public companies for two of them), exchanges now have the primary responsibility of serving their shareholders and not necessarily the public. Any for-profit company wants to take care of their largest clients, and in the exchange business, the largest clients happen to be the high frequency traders.

The Facebook (FB) fiasco has revealed a hidden secret of the exchange model; they essentially have a free put option when it comes to errors. Since the exchanges are still technically SROs (self-regulatory organizations), there is a rule that states there is a maximum amount of money they can pay out for errors. Luck for them, but not so lucky for investors who lost money due to their mistakes.

MV: Speaking of HFT, you note that the president of BATS felt that "High Frequency Trading" became a dirty phrase after the flash crash and embarked on a rebrand by suggesting the industry use words like "Trading and Market Automation." I have a few alternative names like Vig Transfer Engineers, Milli-Second Life, Our Mutual Co-Located Friend and Welcome to The Trading Machines. You have any names and/or acronyms for these guys that are printable here?

JS and SA: Our friends over at Nanex like to end some of their posts with the words, "Good Luck Human." They even use the hashtag #GoodLuckHuman when they post about a quote spike on Twitter.

MV: Excellent, I will start tagging some tweets with that.

"Tyler Durden" of Zero Hedge fame used some parallels from The Matrix in his book review. A thousand times yes! I've warned for years that Dick Bove is The Architect, and it's only a matter of time before he deletes this iteration. I realize he's a bank analyst and all, but can I blame him for the first day of Facebook trading? And if not The Architect, is it safe to assume that was the day of days for The Machines?

JS and SA: Unfortunately, something similar to the Facebook debacle will happen again soon in the equity market. The system has been so corrupted due to years and years of embedded conflicts of interests and poorly designed regulations that have left us with some severe unintended consequences. The equity market is like a house built on a poor foundation. If you drive by on a sunny day, the house looks great. But if a stiff wind comes through, the house starts to rock and shows its instability. Maybe the house doesn't come tumbling down that day, but its shakiness sends its residents running for the exits.

MV: Joe, you're a Mets fan, and Sal's a Yankees fan. Ever worry he's an evil Sith Lord plant?

JS and SA: No doubt the Yankees are the Evil Empire. But they have been squashing our Mets for years now. But something could be different this year. C'mon, a Mets no hitter and Jason Bay hit a home run yesterday? Something must be going on in the universe. Hopefully, the Mayans are wrong.

MV: A friend of mine is a Mariners fan, and we did agree that the two teams throwing no-hitters a week apart is definitely a sign of the upcoming apocalypse. Jason Bay hitting a homer only proves it. But hey, if the world ends in December, at least the Giants will be the permanent Super Bowl champs!

Thanks to Joe and Sal for all your great insights.

Twitter: @agwarner
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