What Business is Wall Street In?

http://blogmaverick.com/2012/09/21/what-business-is-wall-street-in-3/

by uptown • 14 years ago

221 185 14 years ago

dawernik4• 14 years ago

Love Cuban, but his target is program trading, not Wall Street. And trading serves its purpose as it makes the market more efficient. Arbitrage opportunities will always narrow or close over time.

His argument is like saying that someone that buys and sells used cars has a big advantage over me the consumer, therefore buying a car is rigged. I know that implicitly, it's the friction of low transacting.

uptown7• 14 years ago

Someone buying and selling used cars doesn't have the ability to crash the entire car market negatively affecting everyone that currently owns a car in the same way that high-frequency trading can with the stock market. I don't think your analogy works.

dawernik4• 14 years ago

Those crashes primarily impact professionals... I'm not familiar with any enduring crash with sustaind impact to retail investors. I'm sure the value created by tightening spreads and creating volume dwarfs the cost of a momentary crash that impacts other professional traders (and a small fraction of retail traders).

I'm not saying that high frequency trading isn't shady, but it also serves a purpose. And I don't think the objective is to crash a market, it's to make money. These traders don't want scrutiny, so they are personally motivated to maintain order.

JumpCrisscross3• 14 years ago

The used car market is also terribly inefficient.

Lagged2Death• 14 years ago

Love Cuban, but his target is program trading, not Wall Street.

It is my understanding that program trading and HFT account for 99+ percent of the trade volume at this point; how shall we even distinguish Wall Street from automated trading then?

dawernik4• 14 years ago

Trading is different from the initiation of capital investments through different vehicles like stock and bond issuance and the creation of value through M&A. Again, if the argument is trading specific versus wall street abstract, there is a point to be made.

Think how much bacteria is in our body, take it all out and we don't run as efficiently. program trading is the same.

patio11• 14 years ago

It is getting increasingly difficult to just invest in companies you believe in.

Like how twenty years ago you could buy a stock you believed in for like $4 by using a computer system, paying a fraction-of-a-penny spread on average, to have a trade executed in milliseconds to seconds, but now you have to talk to a human on the phone and pay a $400 commission to pay a fraction-of-an-eighth spread and have the trade execute in minutes or hours? That fact pattern would make this critique make sense.

No, it is fantastically easier to trade the stocks of companies you believe in. If there is a problem with the market, the "problem", and one uses that term loosely, is that people are talking about macroeconomic trends more than individual companies because the observable evidence is overwhelmingly in favor of a conclusion we've pretty much known for decades: seeking alpha is a sucker's bet.

mej102• 14 years ago

Trading stocks is fantastically easier, sure. That is obvious. And he says so at the end: "There is value to trading automation. It is here to stay." He never says _trading_ is difficult.

Your comment would be more interesting if it confronted his main point: "There is absolutely NO VALUE to High Frequency Trading. None. We need to bring our markets back to their original goals of creating capital for business. "

PaulHoule• 14 years ago

I think it's a miracle that you can ask for $500 dollars of a thinly traded stock and quite quickly get an offer to get it at $515.

That's how market makers make money. They match up investors who want to buy and sell the amount they want to sell at the time they want to sell it.

Contrast to the private corporation that I own shares in, where it's taken me weeks to broker a deal to buy some more shares from another shareholder -- including face to face meetings with many of the officers of the company. We had to have an accountant do the valuation and I ended up buying exactly the number of shares the other owner wanted to sell because this would mean more financing complexity and paperwork for the hardworking officers who should be spending their time building the business.

Maybe your broker gets $10 and the market maker gets $15 but this is a bargain when you consider how much it would cost without them. Imagine trading on the New York Stock exchange when you were in San Francisco in 1860!

Many low latency (high frequency) traders are market makers. Since the first successful offer gets the trade, you've got to be the fastest to survive at this game.

One reason it's hard to make money as a trader is that as people find discover deviations from ideality and exploit them, the deviations go away. "Market neutral" strategies we quite successful through the 90's but are no longer profitable. Today I'm worried about the options market because trading in volatility may alter the relationship between implied and realized volatility and ruin another family of simple strategies that have performed well lately.

harryh8• 14 years ago

His main poing is wrong.

High Frequency Trading makes trading stocks cheaper. There have always been market makers. They used to be expensive humans. Now they are cheap computers. This means that it now costs less for you to trade a stock.

uptown7• 14 years ago

"It is getting increasingly difficult to just invest in companies you believe in."

You're interpreting that sentence literally. His point is that investing in a company used to largely be based on how successful you though that company would be. The market has changed in a way that an overwhelming number of external factors can have a negative (or positive) impact on that company's share price, making the evaluation of risk far more difficult. At the same time, the barriers to getting into the market have been lowered making it far-easier for anyone to participate. That sentence has nothing to do with how your initial trade was executed.

harryh8• 14 years ago

"The market has changed in a way that an overwhelming number of external factors can have a negative (or positive) impact on that company's share price"

Really? In what way has it changed?

External factors have always had a huge impact on businesses. I'm sure there were lots of super well run businesses that went under durring the Great Depression (which was, you know, the mother of "external factors").

btilly3• 14 years ago

If that is really his point, then he does not understand value investing.

From the point of view of a value investor, the numbers that you care about are the current price, and how successful you think that company will be. If the current price is below that benchmark, you buy and hold. If the current price is above that benchmark then maybe you want to sell short. (The reason for the maybe is that, the market can stay irrational longer than you can stay solvent.) Either way you're aiming to make a profit off of the difference between long-term returns and the price you bought it at.

Therefore from the point of view of a value investor, everything that helps people lose track of a company's long-term prospects is good for you.

ryanwaggoner• 14 years ago

This is only true if you're "investing" on unreasonably short time horizons. And this has always been the case:

"In the short run the market is a voting machine. In the long run it's a weighing machine." - Warren Buffet, quoting Benjamin Graham

RockyMcNuts2• 14 years ago

The market has changed because there are a lot of imbalances that make expected returns bimodal. For instance, either the euro is going to implode, or it's not. Either there's going to be a recession due to [insert Europe/China/Japan/Middle East] or there's not. So in the short run returns might depend on the perceived likelihood of catastrophe (risk-on/risk-off).

Also, with interest rates low, return expectations might have gotten low enough that the significant vig of Wall Street is a bigger problem for some strategies.

meric• 14 years ago

You can always take out market risk by hedging against the index. i.e buy the stock, short the index and bet the stock will do better than the market overall.

larrys2• 14 years ago

First let me say that I agree with most of Cuban's thoughts in general.

But by "invest" he is not talking about the friction out there (paraphrase as "having to spend $400 and talk to a human") to purchase a stock but rather the price of the stock in relation to the value being manipulated by, as one example, high frequency trading and macro economic conditions.

Let's say someone decides to invest in Bingo Card Creator because they think there will be a market in China and that Patrick and BCC are the ones to be able to take advantage of that opportunity. So they invest in BCC because as a small operation, and after doing due diligence, they believe the "new chinese sales manager" that you hired can crack that market. Regardless of what else is going on in the world or in China.

But the truth is even though the stock market is less like that analogy today, I don't believe it was ever like that. (Look at 1929 as one example). Of course in the past I do believe people did make more long term investments. There were places to put "widow and orphans" money. Not sure that is the case today anymore (is it?) And that could also be just because of friction in distribution of investment information - there were less places to read things about companies and that actually helped create more long term investments (my thoughts strictly).

The game now is that people attempt to predict by all means possible what will happen in the future by triangulating any info available to determine how a company will do. And then those companies become bellwether's of the market and people make decisions in advance of those decisions. While this always happened to some extent (I'm sure before people could fly airplanes over shopping centers or before there were even shopping centers there were people who attempted to find out how a particular company was doing by evaluating any information they could. I just think the amount of people doing that was in the minority and now the majority of people are making decisions for non-fundamental reasons.)

djoldman4• 14 years ago

>"but rather the price of the stock in relation to the value being manipulated by, as one example, high frequency trading and macro economic conditions."

Please explain or expand on how the above occurs.

lmm7• 14 years ago

>Of course in the past I do believe people did make more long term investments. There were places to put "widow and orphans" money. Not sure that is the case today anymore (is it?)

I think you can find them if you look for them. Though generally I'd say stick your money in a low-fee S&P 500 tracker; if that's too volatile for you, you probably should be keeping it in cash rather than investing.

hodder2• 14 years ago

I agree with your argument until your last point, "seeking alpha is a sucker's bet". There is ample academic evidence supporting "cheap stock" strategies as improving performance relative to the broader market. Do you disagree with much of what is said in this article?

http://www.tweedy.com/resources/library_docs/papers/WhatHasW...

tlb• 14 years ago

He means it's hard to make money by being a good judge of a company. In the old days you could look at new product introductions and predict better than the majority stockholders (pension funds and insurance companies) how they would affect revenue. They would buy after the next quarterly report showed higher earnings, and you could sell to them at a decent profit. Smart individuals who knew an industry could make decent money. That's no longer true, because HFTs are jumping in front of your transactions.

jeremyjh• 14 years ago

To me this is just him whining that there are no longer market failures for him to exploit. He didn't make lots of money by value investing, he made lots of money by investing in under-priced stocks. That is much harder to do today because the market is better at capturing all the various potential and risk so that a stock price today really does reflect an accurate, risk-adjusted net present value. This means you cannot outperform the market which is his only measure of success.

lonnyk• 14 years ago

I think you are interpreting the term 'invest' incorrectly. He has previously [1] alluded to a difference in the definition of trading and investing.

[1] http://blogmaverick.com/2012/09/04/facebook-handled-their-ip...

marcamillion2• 14 years ago

seeking alpha is a sucker's bet.

Surely this can't be right. If for the only reason that, if it were a sucker's bet, then most people wouldn't take it. Especially most 'informed/rational' actors. The vast majority of the players on Wall Street, we can assume, are informed and relatively rational. Yes, they may follow the herd - but that too is a rational exercise. If you are in a building and everybody is running for the exits, it is irrational to stand still and risk being trampled.

So, the mere fact that there are countless informed/rational actors seeking alpha and - quite frankly, many do capture it - would seem to me that statement is inaccurate.

If your argument is that the odds are long, well that is more nuanced view.

There are many traders that seek a small amount of alpha, with no leverage, and make a reasonable return annually - enough to support say 1 - 2 employees. But, there are many others that do the same with a larger capital base and capture enough to support larger organizations.

Seeking bets with long odds is, quite frequently, not a sucker's bet - because the mainstream view of that bet is that it is a sucker's bet. Mainstream adoption of that view, actually - non-intuitively - turns the bet into a prudent bet. The whole be greedy when everybody is fearful bit.

The same can be said of founders wanting to build the next Facebook - you might argue it is a sucker's bet, but the outcomes aren't as rare as it may seem.

icelancer• 14 years ago

>If for the only reason that, if it were a sucker's bet, then most people wouldn't take it.

The market can remain irrational for longer you can remain solvent.

RockyMcNuts2• 14 years ago

People bet on slot machines too. Can you say, if it were a sucker's bet, most people wouldn't take it?

When I started writing I thought if I proved X was a stupid thing to do that people would stop doing X. I was wrong. - Bill James

For some measure of 'sucker-value', seeking alpha is a sucker's bet, or timing the market is a sucker's bet, or blackjack is a sucker's bet, or poker is a sucker's bet. But there are the few who can find an edge, and don't play when they don't.

A more nuanced point of view is that the market is efficient enough and perverse enough that it takes an unusual ability to find alpha, or time the market, or to pursue any strategy. So if you don't have those, then it's a sucker's bet.

As a thought experiment, consider what would happen if (nearly) everyone indexed. Anything outside the index would be super-cheap and illiquid, and the index would be expensive in comparison. In that case, non-indexers would outperform. (Efficient market theorists would of course argue it was an illiquidity and risk premium and the market is still efficient.)

In the real world, the market finds an equilibrium between indexers and non-indexers where some can generate alpha, enough to persuade a lot of people that they're alpha generating when they are just fooling themselves. It's really people's ability to rationalize and fool themselves that explains the persistence of alpha-seeking strategies, not their success.

Paradoxically, when dumb money acknowledges its limitations, it ceases to be dumb. - Warren Buffett

I agree with you that it's possible, but hard to outperform, but mostly for a different reason. Partly because the market is somewhat efficient and rational, but mostly because where and when it's irrational, it inherently mirrors the irrationality of the human participant in ways which almost everyone will struggle in vain to overcome.

paulsutter• 14 years ago

He's making a distinction between trading and investment. The purpose of the stock market is raising capital to start/grow/sell companies (investment). The technical term for high frequency trading is "scalping" (yes, exactly the same word and meaning as ticket scalping). HFT traders like to think they "create liquidity", but I haven't heard a credible argument to support that.

Divide the market into three categories of participants:

A. Holding period less than one minute (high frequency traders)

B. Holding period greater than one month (entrepreneurs, companies, value investors)

C. Everyone else (noise)

Question: Does category A really create any useful liquidity for category B? Category B is the economic purpose and intent of the stock market. He's saying: that the HFT guys are like trolls living under a bridge stealing a shoelace from each person who crosses the bridge. He's saying that doesn't fulfill an economic purpose.

I'd love to hear a counterargument. I don't know enough to have a firm position.

lifeisstillgood9• 14 years ago

My view (possibly wrong, it has been known) is that liquidity need only be provided by one party. A competitive Market in liquidity has minimal benefits

it is unimportant if the Market maker holds for 1 pixo second or one month - what matters is that someone is there to trade. Now HFT is at a disadvantage as they have less scope to make their spread (essentially the other side must already be in the Market) but that's where if all other Market makers disappeared (and the stock slowed down) HFTs must become LFTs and hey presto are indistinguishable from the old style Market maker

yes there is a price point issue but most buyers really have a range they will buy at so more precisely I am conjecturing that there are minimal benefits to an exchange to having more than one Market maker at a given stock within a given price range.

How to provethat - not sure

Evbn3• 14 years ago

If you place a limit order you can be the one stealing shoelaces. Or you can be your shoelace in exchange for getting instantaneous execution, just like you pay your ISP a shoelace for the megabyte of data used to send the order.

mayukh• 14 years ago

There's a difference between retail trader and retail investor. If Joe Schmo is a trader, looking to earn profits in the short term (days, weeks, < 6 months), the odds are heavily stacked again him, with HFT (i am kinda in agreement with Cuban there). If Joe was an investor, seeking out good companies and buying stocks with the intent to hold on to them for the long term (1 yr+) then HFT should have lesser impact. Ofcourse an investor could have made the wrong call, but then the outcome of a stock moving up or down over the long run should be related to the actual performance of the company in the real world, not some alternate universe dominated by hft algos seeking arbitrage opportunities.

bearmf• 14 years ago

HFT happens on millisecond scale. That is what they mean by "short term" now.

If you are going to hold a stock for weeks it will probably not affect you at all. Even if your holding period is several hours you are not really competing with HFT.

JumpCrisscross3• 14 years ago

Individual investors outperform the market over a 20 day holding period and that "these patterns are consistent with the idea that risk-averse individuals provide liquidity to meet institutional demand for immediacy." The expected return for an individual investor deteriorates as time horizons get shorter and longer than 20 days, with professional traders dominating individuals at the shorter end and professional investors at the longer.

http://archive.nyu.edu/bitstream/2451/26930/3/CFE-04-04.pdf....

crntaylor2• 14 years ago

A high frequency trader wants to jump in front of your trade and then sell that stock to you.

Can he explain exactly how this is supposed to happen? Let's think it through. You see a stock priced at B, and you decide you want to buy it. Cuban is saying that a high frequency trader will see that you want to buy the stock, and he'll buy it for B and then sell it back to you at B+X, making X in the process (any you pay more for the stock). To do that, he'd have to know that you were about to submit an order. But he only finds out about your order after you've submitted the order to the exchange, and the exchange has relayed it to him. He doesn't get the opportunity to "jump in front of you", and I have no idea why Cuban thinks he does.

In actuality, what happens is this. The high frequency trader sees that the stock is priced at B if you want to buy it, and S if you want to tell it (with B > S). He then expresses his willingness to sell you the stock at B-X (by sending a limit order to the exchange). When you come along to buy it, you get it at B-X instead of B, which saves you money. The trader gets a rebate from the exchange for supplying liqudity (which he did, since you got the stock for less than you would have otherwise) and hopefully he is able to buy it back for some price around S (with another limit order), thereby making the difference between B-X and S.

There are dangers with high frequency trading [1] but they are not of the kind that Cuban is describing.

[1] http://en.wikipedia.org/wiki/Knight_capital#2012_stock_tradi...

bensw• 14 years ago

This can actually happen with things like "breaking the iceberg"--playing tricks with the order book, but like you said, there clearly exist dangers with HFT, to claim that all HFT is evil is just flat out wrong.

CJefferson• 14 years ago

Except, that isn't all high frequency traders do.

They send in tens of thousands of requests a second, many of which they have no interest in ever being forfilled, in the hope of partly fooling other people, who are sending around similar numbers of requests.

Stock exchanges have turned into a high-frequency war-ground, which fortunately doesn't appear to spill out and effect the rest of us too often, at least as far as I understand.

ArchD• 14 years ago

Many exchanges have limits on the number of order cancellations you can make. You get penalized if you send too many cancels compared to the number of trades you get.

Besides, most retail orders go through brokers, not directly to the exchange, and the brokers can provide their own layer of algorithmic sophistication to help the clients get a better price than if they were to place the orders on the exchange on their own directly. This can be done by internally matching orders on both sides, as well as placing orders at strategic times and prices, also using algorithms.

So, this isn't really about "poor retail investor" against "evil predatory high-frequency trader".

kingcub• 14 years ago

>They send in tens of thousands of requests a second, many of which they have no interest in ever being forfilled, in the hope of partly fooling other people, who are sending around similar numbers of requests.

That's called gaming, and is illegal.

crntaylor2• 14 years ago

Most exchanges that I have experience of have a minimum trade-to-quote ratio, i.e. at least a certain proportion of your quotes have to turn into trades, or you'll be warned and eventually kicked off the exchange.

In any case, to the 'end user' (a regular stock investor like you or me) the continual jockeying for position among HFTs doesn't matter - all we notice is that we pay smaller spreads and get our orders filled more quickly.

Sometimes the trading games spill out into the 'real world' with unpleasant consequences, but those instances appear (so far) to be rare. I think there needs to be tight regulation on HFTs to limit behaviour like quote stuffing, spoofing and other forms of gaming, but I don't agree with the argument that they are a net bad thing.

debacle2• 14 years ago

> or changing the capital gains tax structure so that there is no capital gains tax on any shares of stock (private or public company) held for 1 year or more, and no tax on dividends paid to shareholders who have held stock in the company for more than 5 years.

A complex tax structure ignores the bottom (who pay very little tax on income) and only harms the middle. The top earners in any system with a complex tax structure have the capital and the assets to make it worthwhile to design vehicles that shield them by exploiting these complex tax rules.

adambyrtek3• 14 years ago

The analogy between hackers and traders is interesting, but the argument would have been even better if the author hadn't assumed that hackers have to be criminals:

"A hacker wants to jump in front of your shopping cart and grab your credit card and then sell it."

On the other hand, looks like we've already lost this fight.

platz• 14 years ago

Yep, I came here to post this exact sentiment.

JumpCrisscross3• 14 years ago

Wall Street's business is facilitating the capital markets, not "creating capital". Equity underwriting, a white shoe Wall Street activity, involves simultaneously facilitating a series of transactions we call an IPO. Creating capital is not really anybody's job - you can create capital/money by agreeing to take an IOU in lieu of cash for services rendered.

Also, Wall Street != algo/program/high frequency trading. That area of the capital markets, which requires sophisticated market infrastructure to exist in the first place, is exceedingly small by headcount and profit share.

>"The best analogy for traders? They are hackers."

Traders are hackers, and so are entrepreneurs. The kind that likes to tinker with data, play with mathematical models, and find nuances previously un-noticed or empirical anomalies irrational. The dream is to, in the process, find a way of modelling phenomena presently deemed unpredictable, i.e. to discover something new.

>"Discussion in the market place is not about the performance of specific companies and their returns. Discussion is about macro issues that impact all stocks."

Adam Smith didn't write about economics, he wrote about the political economy. The post-War trend of having a secular divide between politics and markets is historically unprecedented. Discussion has shifted because the salient points have shifted; beta is dominating alpha. A visual could be a slick of oil on top of an ocean - the oil is company-specific factors and the ocean the general market. In calm seas just watching the oil is fine. If you're in a Hellenic thunderstorm, however, the dominating factor is the rolling waves. Don't blame someone else because your model is obsolete.

>"I would be curious if anyone out there knows what percentage of transactions actually return money to a company for any reason"

I'm not sure what this means, so I'll take it as what percent of revenues came directly from capital raises (IPOs and debt offerings). This supposes that all other functions at the bank, e.g. asset management, making markets in stocks, providing brokerage and execution services, etc. are useless. From their latest GS 10-Q [1] we see that they earned $1.4 billion in underwriting for the first half of 2012. Not including net interest income their revenues for the same period were $14.5 billion; thus, underwriting represented 10% of Goldman Sachs's revenues for the first half of 2012. As a percentage of transactions I'm not sure how you'd work this out (is an IPO one transaction? Multiple?) nor what use it would be. For reference, underwriting represents nothing of Blackrock's or Bridgewater Capital's revenues.

>"Wall Street as a whole needs to be in the business of creating capital for companies and selling shares to investors who believe they are shareholders."

A healthy primary market cannot exist without a healthy secondary market, i.e. the success of an IPO, and whether it happens in the first place, is strongly related to how investors feel about being able to sell at some point down the road without incurring losses.

Let's examine the connection between holding term and governance mentality. The FT recently had a piece documenting that institutional investors, who own roughly 70 percent of U.S. stocks, despite having long-term positions and near total voting control, tend to by default vote with management and not participate in corporate governance [2]. Resolving our public capital markets is more complicated than fuck the facilitators; ape-handedly throwing taxes around before thinking through the consequences, intended and otherwise, isn't smart (though it will evidently get your article views).

High frequency traders, in a race to the bottom, are in the short-term being run into the red by firms that trade time-consuming safety checks for speed. In the end the bad drives out the good and the market de-stabilises. The solution to this is having a series of pre, inter, and post trade checks that have to be run, e.g. monitoring the total dollar volume of trading over a time interval or the total dollar amount lost mark-to-market (yes, there are firms that took these functions out of pre-trade verification to save a few milliseconds). This puts a natural and non-arbitrary speed limit on the markets which accomplishing something meaningful in that time beyond feeling good about having conducted a witch-hunt.

[1] http://www.sec.gov/Archives/edgar/data/886982/00011931251234...

[2] http://www.ft.com/intl/cms/s/0/e19b6a54-fbf8-11e1-aef9-00144...

javert• 14 years ago

Mark Cuban, go create your own exchange where you set the rules, or STFU.

That's why we live in a free society.

There is no valid reason or excuse for putting a gun to someone's head and telling them, "stop trading or else," which is what you keep insisting on.

SeanLuke• 14 years ago

You're saying that the stock market has no effects on society?

twoodfin2• 14 years ago

Everything has an effect on others. The question is whether those effects are the result of voluntary actions. As far as I can tell, nobody is being forced to invest on Wall Street. Everyone is free to keep their money in gold or under their mattress.

Now, if everyone chose to do those things, that would have a huge negative effect on society, massively greater than anything Wall Street has ever inflicted. But that doesn't imply we should regulate how much people are allowed to buy gold or stuff their mattresses.

signalsignal• 14 years ago

Mark Cuban is only human, and I was wondering why he seemed to take that huge Facebook loss so lightly.

programminggeek• 14 years ago

HFT, brokerage houses, and wall street in general is about providing the service of being a middle man and profiting from standing in the middle of a transaction. Traders via automated machines or human beings facilitate a transaction between a buyer and a seller. That's the business. It's not about providing capital or whatever else people think it is, it's about being basically a sales agent.

Before computers, Wall St. was still largely about trading and standing between people who have money and people are willing to trade ownership for money. That's it.

The problem is that HFT is about profiting on even the smallest trades, but cranking up the volume to 11. It's kind of like what Wal-Mart did to retail, they make less money per item, but they literally make it up in volume.

Algorithmic trading can be slow or fast, but it plays off the fact that machines can compute the data and make a decision faster than humans can, especially on a digital marketplace.

It is unfair to human traders, sure. But, you have a digital trading platform, so at some point it's impossible to stop algorithmic trading.

If you want a market where the purpose is to create capital for businesses without dealing with machine trading, you need to start a new market that is not run by machines and is only operated by human, person to person trades.

drawkbox• 14 years ago

I am not usually a fan of regulation but his 10c tax for trades in less than an hour may help this out big time. It really is just like API throttling so people or consumers don't abuse the systems for all. Then again day trading and hedging is a big part of investment portfolios now and this would change things big time.

Whether its through a use of taxes on trades(hit every trade on a stock held less than 1 hour with a 10c tax and all these problems go away), or changing the capital gains tax structure so that there is no capital gains tax on any shares of stock (private or public company) held for 1 year or more, and no tax on dividends paid to shareholders who have held stock in the company for more than 5 years.

There are probably some edge cases where a time based tax would be a problem but for the most part I think it would drastically reduce the HFT skimming. Then again, if you are making money on the market you are probably doing the skimming.

A big problem for markets is weak or too many short term investors, they can create a snowball effect. HFT trading algorithms are very short and can create flash crash windfalls. Luckily they can also buy up when those things happen and the whole thing is over in a blink but that seems too risky. What happens when all the trades are by HFT algorithms? Eventually if those make all the money then everyone will use them all the time. Where are the long suckers then?

mcantelon• 14 years ago

Animated GIF showing, visually, how HFT has impacted the overall flavor of the market:

http://imgur.com/DxWer

Tipzntrix• 14 years ago

I gather that Mark is upset that HFTs use stocks as pawns and resale merchandise here. Essentially, HFTs buy stocks just because the supply and demand numbers look right. These algorithms most likely don't do research into the background of a company, they don't do character checks on executives, and they don't look at what kind of expertise the staff or board has. They just look at the buy/sell rates historically and take advantage of good opportunities. They're essentially middlemen in between the buy and the sell rates, and feel a lot like retail stores. You could almost compare them to Wal-Mart. Get whatever the hell goods they can, give a better rate than anyone else, sell to people who actually want the goods. However, they are not buying stocks as a sign of faith in the company, which is what I think Mark Cuban believes is the real point of the stock market.

godisdad• 14 years ago

An interesting company in this space trying to return control to the investor: https://www.secondmarket.com/

A talk by the founder at Stanford: http://www.youtube.com/watch?v=jH-wyaS2Rn0

hodder2• 14 years ago

Why is there such a witch hunt against high frequency traders? I understand the brain-drain argument, but I fail to see a direct negative impact on regular investors.

-High frequency traders provide liquidity enabling me to transact with slightly lower spreads. While narrow spreads may only provide a marginal benefit to the markets, how is it harming you or I?

-High frequency traders hardly impact my investing decisions. Has anyone here been burned by a high frequency trader? If so, please share your experience.

-I am unaware of any academic research concluding high frequency trading has caused harm to individual investors.

-The flash crashes that have occured, appear to have been temporary in nature, and therefore have had zero impact on real investors.

-Don't use market orders if you are afraid of getting a trade executed at an irrational price.

-if PG, KO, or similar crashes for a few milliseconds as a result of high frequency trading (which may be a dubious claim) how does that hurt you? You may have the opportunity to temporarily exploit a mispriced security and buy shares of a company at a lower price.

lmm7• 14 years ago

>Why is there such a witch hunt against high frequency traders?

There's a decent chunk of jealousy involved; I think it's mostly the way they seem to be making a large amount of money while not doing any "real work". Compare the general attitude towards lawyers.

jcfrei• 14 years ago

the main, reasonable complaint against HFT (at least from my perspective, besides brain-drain) is the introduction of a higher volatility. since pension funds and other institutional investors dont usually have them same well trained funds managers and sophisticated analytics, yet a much higher volume, they are usually the ones who get it in the pants. the loss might be fractional, since you are usually investing long term, yet a short fluctation (eg. 2 cents, after you started executing your orders) in prices does add up if you're investing upwards of 100 mil.

lifeisstillgood9• 14 years ago

   However we need to do it, we need to get the smart money
   on Wall Street back to thinking about ways to use their  
   capital to help start and grow companies.

This is the meat and potatoes quote. Founder Visas, Ycombinator, Disrupt, the death of VCs, the new VCs, all of these do shout that someone has dropped the ball, and a new breed of investors have picked it up.

I still look at Prof. Sadoway and think how will he get the investment he wants from US markets. Its either VCs, Green Funds or soverign funds making all the running - the business of creating new businesses seems to have fallen out of favour.

Proof - none that you can speak of, except for my bones.

BenoitEssiambre2• 14 years ago

In the past few years, I've been a fervently anti-bank corruption, often aligning myself with the occupy wall street crowd. However, unlike most people with my views, I see algorithmic trading as not a symptom of, but one of the solutions to the problems in investment banking.

Maybe it's because of my background in machine learning, but I view computers as a way to reduce the amounts of arbitrage opportunities and insider knowledge that can be exploited by traders to enrich themselves on the back of others.

Well programmed computers are able to use NLP techniques to read thousands of news articles, reports, financial statements, government data, demographic data , analyse millions of data points, sort which ones are important, build predictive models, and do it all in a few seconds of time.

A few computers can do the job of thousands of traders, do it with less bias and with better mathematically proven decisions.

Nowadays every time a human trader tries to beat the market by predicting short terms swings in prices, there is a computer on the other side of his internet connection that is relying on much more information and even models of the human's own personality and biases to trade against him. This means that unless the human has inside information that is not accessible to the computer, (and I'm sure those who operate these computers try to feed them or make them infer the greatest amount of direct or indirect insider knowledge as possible ) it will tend to be impossible to beat the market.

With the greater amount of information, the computers will keep the prices closer to real world fundamentals, bust bubbles before they inflate and reduce all the price swings that traders used to be able to exploit to make a profit on the back of less sophisticated investors.

By making obsolete the jobs of all these traders, they are making the market much more efficient. They are automating a kind of job that didn't produced any real goods. Hopefully, pushing these people into jobs that make something real instead of skimming the top of everybody's retirement savings (I can see why those who want to be traders would be upset about this).

Ah but you say, all we have done is replace humans from skimming our retirement savings by machines that do the same. This would be true if there was only one computer system competing against the human traders but there is a whole industry and they also compete against each other. Two sophisticated machines that trade against each other, will not only beat the human trader and put him out of business but reduce the arbitrage opportunity and margin each of these computer systems can exploit.

Contrary to what the article states, computers that compete against each other will tend to eliminate all short term unjustified price swings and leave only accessible prices based on real company fundamentals. Only long term traders that bet on fundamentals will be able to make money and they will make more money than when they were subject to be exploited through market distortions and bubbles.

This can all be proven by something called the efficient market hypothesis:

There is a great explanation by Glen Whitman of Agoraphilia, that uses grocery line wait time predictions as a metaphor: http://agoraphilia.blogspot.com/2005/03/doing-lines.html

http://en.wikipedia.org/wiki/Efficient-market_hypothesis

Ntrails2• 14 years ago

I find this idea that all the investment managers in the world exist simply by skimming off peoples retirement savings mind boggling.

There are two main kinds of retirement savings, those where the retiree is in control of where their money goes - in which case they can choose to invest it as they wish. In an index, a company or anything else, and those where a company is investing on their behalf but with a legal obligation to pay out.

Now, if the company goes bust then that is not the fault of HFTs or managers skimming. Either they failed to make adequate contributions or they simply went bust because the business failed.

If you invest your money in ACTIVE MANAGERS then you'd best know who they are, what they do, and why they think they can win in a negative sum game. By definition very few actually can.

HFT is not the cause of pensioners going without - that is a combination of lack of contributions (based on unrealistic expectations) and poor investment decisions. They don't prevent you from spending all your money on Apple shares and making a killing, and nor are they to blame if you invested in Northern Rock and lost everything.

It is a fact that more money is spent on portfolio transaction costs for large pension schemes than any other cost. It is also true that much of it is unnecessary. But these are functions of investment choices based on active management, along with poor implementation and usually high management turnover.

Retric2• 14 years ago

What a lot of people are missing is "the market" can't grow faster than "the economy" over the long term. There has been a huge influx of money into the stock market as an increasing percentage of people hoping for historical returns. Causing people to chase after ever lower returns. It's gotten so distorted that the 'smart money' practically ignores growth in favor of other games.

HFT is the perfect example of this as they don't chase growth. There goal is to tax cash flows and market inefficiency. So, they leave low churn stocks like Berkshire Hathaway alone in favor of cheap stocks with a lot of turnover. If you keep your stock for an average of 10 years then HFT is meaningless to you. But, with hedge-funds often doing quite a bit of trading they can extract money without you realizing your trading.

In the end it's yet another reason 401k's are growing a lot slower than many people predict. Sort of like how people expect the economy to 'recover' when it was what there remembering is an unsustainable bubble.

PS: And of course Dividends are something of a special case in the above analysis.

schneitj• 14 years ago

There are lots of ways to extract rent from the system.

I've read some stories where a pension / 401k plan was placing a large trade and HFT was able to detect it in progress and make money off the transaction. Look up front running, placing bids and withdrawing them, etc.

Even if you trust your investment manager, there are shenanigans going on in the system. The stock market isn't what it used to be.

mej102• 14 years ago

While ultimately I do agree with you, especially about humans trying to beat HFT in the short term, I don't think HFT and algorithmic trading are _currently_ the panacea you are making them out to be.

http://en.wikipedia.org/wiki/2010_Flash_Crash

BenoitEssiambre2• 14 years ago

I agree that the system is not perfect because, lets face it, computers are not always that reliable. However, this is a problem that solves itself. If an algorithm goes haywire and drives the market down temporarily, that computer stands to lose a whole lot of money so there is tons on incentives to fix or retire that particular machine.

Otherwise it would be easy to make a very profitable algorithm on the back of the machines that create flash crashes by detecting those crashes and buying tons of shares when they are discounted in order to sell them back when prices returns to rational levels. By buying on the crash this algorithm would push the price up thus reducing the price swing.

JamisonM• 14 years ago

It seems to me to be naive to believe that a bunch of computers running software built by humans will compete perfectly to create a perfect market, the hypothetical "efficient market".

Instead what you would probably arrive at is an arms-race of retail investor-accessible HFT systems competing for investor dollars. That arms-race would just lead to a market even more arbitrary than the one we have now where the HFT systems are using fundamentals and at the same time learning about the trading patterns of the other systems indirectly to exploit them. Investors would be investing in the trading system instead of the real market, it would be reduced to gambling on the race instead of investing in the market.

My personal opinion is the HFT systems of today add zero value, as argued in the article. The liquidity provided by them is an illusion as they skim a cut off between the original seller and their buyer on the two ends of the trades they perform.

jquery• 14 years ago

> Contrary to what the article states, computers that compete against each other will tend to eliminate all short term unjustified price swings and leave only accessible prices based on real company fundamentals.

This is assuming that computers only try to extract money by going long on every stock they purchase, an incredibly ignorant view of finance.

nhaehnle• 14 years ago

> This can all be proven by something called the efficient market hypothesis.

Of course, the efficient market hypothesis is basically an unproven assumption.

The general gist of it is obviously somewhat reasonable, but you have to be extremely careful what kind of statements you really believe.

Just to make two obvious examples: the strongest form of EMH claims that asset prices reflect even hidden information. That cannot possibly be true, because the circle of people with access to that hidden information most likely does not have enough money / market power to affect a shift of sufficient size.

The other example: slightly weaker forms of EMH still claim that prices adjust immediately to new information. That cannot possibly be true either, because traders simply aren't that fast. HFTs typically cannot afford to put so much money into affecting big price shifts, and other traders are slower. Besides, it's clearly falsified empirically: if this form of the EMH were true, stock prices would look like step functions, and they don't.

Another argument against EMH is complexity theoretic: one can most likely show that if EMH were true, the market would solve NP-hard problems efficiently (I remember seeing a line of work that attempted to show such a thing, though obviously the modeling is very messy).

Now you might argue that EMH still somehow approximates the real world. Maybe. But small errors can add up, so you have to be really careful in your thinking.

endtime• 14 years ago

> That cannot possibly be true either, because traders simply aren't that fast.

Forget traders...our universe has a speed limit.

001sky• 14 years ago

I see algorithmic trading as not a symptom of, but one of the solutions to the problems in investment banking This is incredibly naive. Amazingly so.

"This can all be proven by something called the efficient market hypothesis" really? This is even worse.

Front running is a betrayal of the fundamental behavioural "assumptions" underpinning economic theory. By definition, without these assumptions, there is no EMH. So this whole thing falls apart.

That's why this is such a problem. If you really believe in markets, the first thing you do is make sure their underpinnings are not corrupted.

Its not clear that OWS believes in markets. The critique I'm outlining above is a seperate position alltogether.

aqme28• 14 years ago

I'm just going to handle this one point: "Nowadays every time a human trader tries to beat the market by predicting short terms swings in prices, there is a computer on the other side of his internet connection that is relying on much more information and even models of the human's own personality and biases to trade against him. This means that unless the human has inside information that is not accessible to the computer, (and I'm sure those who operate these computers try to feed them or make them infer the greatest amount of direct or indirect insider knowledge as possible ) it will tend to be impossible to beat the market."

This isn't accurate. Computational trading uses models and algorithms. Even if the computer has all the information necessary, sometimes the models themselves have flaws. We're not at the point yet where the computers are making these perfect, predictive models. The humans who make them will make incorrect assumptions. We saw this issue big time in 2007, and we'll see it again.

zerostar07• 14 years ago

Assuming that in the future most trading will be done by computers, this means that in a large part the market will be deterministic, or at least predictable, but not rational or contributing to a better economy. The whole idea of stock markets is to have people apply their sensibility so that the economy moves towards what will be "a better future". Since only people know what is good for them, and 'good' is not possible to define as a specific set of optimization problems, i don't see what is the value of an automatically-trading market.

ShabbyDoo• 14 years ago

"It is getting increasingly difficult to just invest in companies you believe in."

So, let's say that Mark's right and the combination of HFT and emphasis on macro trends has caused some securities to be mis-priced compared to his analysis of their long-term prognoses. As a long-term investor, shouldn't he be delighted for the opportunity to bargain shop? If anyone can stay solvent longer than markets stay irrational, it's him.

mattmaroon• 14 years ago

Cuban is just griping about something he doesn't even understand here. There was a great article about it here a couple months back. There is value to HFT. It creates liquidity in the market. It doesn't make long-term investing any different at all. It's just an automated version of the same market making that's been done manually for decades.

Wall Street has a lot of problems. Computers making markets instead of humans isn't one of them.

chernevik• 14 years ago

This sounds like liquidity is a bug rather than a feature, because those secondary trades don't send capital to the companies. But that liquidity is part of why the primary capital went into the company, and that liquidity supports a flock of risk management and information signalling functions. So I'm not sure why the focus on liquidity per se.

Given that the rejection of HFT has to be overbroad. If they liquidity they provide is the sort of that supports the functions we like, who cares what their holding periods are?

It certainly seems true that Cuban is right about "hacking" the market insofar as yeah, a good deal of HFT sounds like exploitation of rules and procedures to avoid creating the fair market intended. But that means there is "bad" liquidity, which doesn't serve our purposes. Okay, so let's write rules that better serve our purposes for liquidity. (And if we're worried about market distortions from bad trading liquidity, what about the market distortions from Fed provision of currency liquidity? The wash of cash has lifted all asset prices, it's hard to see economic signals when price correlations are moving to one.)

Cuban seems to think we can do just that by manipulating investor incentives -- give them tax breaks for holding periods, tax transactions, etc. But all of these just make the market more complex, and increase the differential between investment categories -- all of which creates more incentive for financial hacking and further detaches pursuit of financial return from realization of economic return. It makes the rules less comprehensible. And it gives the politicians and regulators more to do in the markets, which makes them more attractive targets for lobbyists. He's increasing the incentives for soft corruption while making it harder to spot, the consequences are easily predicted.

Cuban is a smart and pragmatic guy with billions of reasons to think himself smarter than the average bear. Part of his smarts are an ability to keep it simple, and an instinct when things are out of whack. But here that instinct have lead him through simple on to simplistic.

jimdanz• 14 years ago

What is this guy's deal? He posted almost the exact same blog post over a year ago. http://blogmaverick.com/2011/08/08/what-business-is-wall-str...

boh• 14 years ago

Great article explaining high frequency trading:

http://www.economist.com/node/21547988

plc8• 14 years ago

It is not a zero sum game between you and HFT. It IS a zero sum game between an HFT firm and another HFT firm, or an HFT firm versus people specialist traders. You think that burly guy from queens who used to be a janitor and now works on the floor of the NYSE will give you a good price? HFT cuts the line in the sense that it competes with him to give you a better price. HFT firms are fast to compete for your business vs other HFT firms. HFT and the average retail investor is not a zero sum game. It is mostly zero sum between HFT and the old system of specialist traders. It turns out the biggest critics of HFT are the old specialists who have lost their jobs and people who do not know what they are talking about.

So say you trade against an HFT algorithm. If you are talking about the narrow context of the trade, it is zero sum. But that is not how the world works. Bill Gates can sell a share of Microsoft to a market maker trader/HFT. Say he does this for $26.00. Tomorrow, it goes to $30.00. In the context of the trade, Bill Gates "loses" $4 to the HFT algorithm. But that is not the whole story. He took that $26 and did something with it. Maybe he helped fund a startup which has created value and doubled his money. So now the HFT trader is up $4, and Bill Gates is up $26. Zero sum, huh? Or maybe he invested it in a Malaria vaccination program that has no easy dollar valuation but is clearly positive to the world. This is why in the context of the system, everyone can win, and it can be a positive sum game.

If you invested your savings 18 years ago for your kid to go to college, at some point you will sell that stock to raise cash and pay for college. You are investing in your child's education, so that he can have a good life, invent things, cure cancer, solve P vs NP, improve Shor's algorithm, and more. That seems like a good return, even if 4 years later the HFT algorithm you sold your stock to made money because the stock went up.

When the world changes, prices change as well. As an HFT firm, you are always sending prices that are competitive for customers. HFT being fast is the effort to improve prices as quickly as possible, or admittedly, pull prices if they are no longer fair. Often, this is a typical scenario for an HFT firm…news comes out on a stock that is positive. The old bid for the stock was 20.00. That means if you are sending an order to sell your shares in the stock, to say, raise money to send your kids to a good college, you will hit the bid at 20.00. If HFT is not fast, you will get $20 for your share, even though the news hit 2 seconds ago. HFT algorithms compete for your business in the sense that they try to be fastest to improve that bid price to 20.05. If they are not fast, you get $20. If they are fast, then you get $20.05. What is the problem here?

The bottom line of all this misunderstanding is, I believe, a distrust of where all this money is coming from that they make. It's simple--it's from them cannibalizing the old human, specialist trader business (do you know how many billions they made from retail before HFT?). It's no different from a startup upending an old industry veteran by undercutting their prices by 90% and taking away all their business.

pixie_• 14 years ago

There is little productivity created in the wall st business. As the author states little of what Wall St does is raise capital for companies. Mostly it facilitates trading stock which is basically people trying to make money off of other people who have enough money to buy stocks. You buy your 'chips' and trade them and hope to make a profit. As far as the rest of the economy is concerned, little productivity is created from this action. It's as productive as gambling is, which would be analogous to Wall St's true business.

its_so_on3• 14 years ago

i'm about to make a nuanced, technical argument, and i don't know if it's correct. if you understand it, your feedback is appreciated.

so, i believe information asymmetry is possible. i believe that many good ideas are in such a relationship with the world that the people who have them have an asymmetric advantage over those who don't: that possession of the idea equals wealth, as long as you are attempting to execute. (wealth in the net-present-value sense, not liquidity sense.)

this gives you the interesting situation that you can be walking along the road and, if you are the right person and respond properly, you can immediately in a bolt out of the blue become richer by the net-present-value of the idea you are just struck with: provided it is one of those asymmetric ones and you proceed to execute on it.

now. now, for the larger ideas (like Google), the net-present-value was in the millions. but if the people doing it had actually had millions of liquidity, they would not have been coding: they would have hired a coder.

so please assume p, where p is "a person with a net-present-value of $n million is currently coding something which will make money and then allow him to hire coders. assume that with probability 1 he will succeed."

as he is coding, before he actually has succeeded, what business is he in under p?

i would say he is in the information-arbitrage business. he is coding at $0/hour against the net-present-value of the idea he has. it seems to me kind of an arbitrage thing.

this is assuming p, which means that this is an assymetric condition where with probability 1 he pays off. obviously it becomes more complex as we get into probabilities other than 1 - but is this a fair conclusion about the startup hacker?

that he is arbitraging information asymmetry?

as i mentioned at the start of this comment, this is a technical argument and i'm not sure of its validity. any feedback is appreciated.

if you hate my assumptions (specifically, p) i still would appreciate to go with them as well as any other thoughts you may have, which you can address separately.

josephlord2• 14 years ago

I think I understand and don't think that you are necessarily wrong but I'm not sure it is a particularly useful way to look at the world.

Enron was famous for booking predicted lifetime profits based on the ideas that they had and look how that turned out. It isn't logically wrong but it probably is too hard to do realistically, not just predicting the profits in the first place but updating them with circumstances.

If your person had his bolt in the blue and became richer the moment he/she heard about a competitor launching before them with a similar idea would instantly become poorer (as they wouldn't have the market to themselves) and they should remark their book value.

BTW without capitalised sentences and in stream of thought style I found this really hare to read. I suggest you work on the presentation before explaining it to anyone else.

its_so_on3• 14 years ago

sorry about the format, i'm intentionally trying to not so much to be accessible as to reach certain people who might already know. i'd like their feedback.

you are completely right that it's hard to peg the shift in present-wealth without a crystal ball, which nobody possesses - moreover, the future isn't even written.

so let's give you the crystal ball - it jumps wildly between valuation your net-present at a few million and hundreds of millions and sometimes billions and sometimes tens of billions and then millions again. it's useless.

but suppose that it is quite consistent that the idea is worth at least $20 million in net-present.

so, in this case - what is going on here when you, an only "competent" coder, are coding the idea yourself? Why would a millionaire code at a quality he could barely sell in the market (not being a coder), and which is just enough to show a prototype which gets funding, which gets the ball rolling, which... (all the things that lead to the net-present jumping between $20 million and billions, but never lower than the former).

So, what is going on here? Why is the person working at $0/hr producing work that's worth maybe $3-$4/hr? (buggy poor-quality spaghetti code php with no source control, for example.)

He is also directly losing a wage he could be earning elsewhere.

what is this behavior? What is going on here?

one answer could be, couldn't it, that he's producing low-quality, poor labor, because he has the chance to buy a chunk of a high-quality idea with it?

i mean, i personally know of a lot of stories of hundred-million dollar exits that started with an idea that the founder started following up on by-

- doing poor-quality accounting and business founding,

- poor quality legal research

- poor quality coding that had to be thrown away after his company was bigger

- poor quality biz dev that was mostly spinning company's wheels

a lot of other things of very low quality...

... but of quality just high enough that the idea pulls the company through, and his preconceptions can be changed by high-quality lawyers, his code is thrown away and rebuilt by real engineers, his b2b attempts are repeated by someone who can actually push deals through, his logo is replaced by a real logo that doesn't make you laugh, and so forht.

so, what just happened in this whole last example? what was the beahvior that led to it? (in abstract, theoretical, technical terms).

i want to know why he's buying his own low-price, low-quality labor, and why this works.

pedalpete• 14 years ago

`It is getting increasingly difficult to just invest in companies you believe in.`

I disagree with this. How many people believe in Apple as a company and invested in it's growth over the last 8 years. Or Target over the last 3 and there are many others.

The challenge as I see it is that it is very difficult for the companies to actually leverage the growth in their stock prices. The companies need to buy and sell their own stocks in order to use the money as investment. Unless I am missing something huge here. Most of the time it seems it is only an incentive to management that the stock price increases. But really, the capital isn't invested in the company, it is gambled on the company.

hooande• 14 years ago

HFT is gambling, pure and simple. I bet the price is going up, someone else bets that it isn't. Personally, I don't have a problem with gambling and I don't care if other people do it. It certainly sounds sketchy, given that they are using millions of dollars of other people's money. But they know the risks and they do a decent job of managing them. This is no harm, no foul.

I think part of the point (maybe Cuban's point) is that gambling isn't helping anyone, either. Financial markets were designed in theory to get capital to the right companies. HFT is a lot like a Native American casino...there was something much more profitable to do with the real estate than it's intended use.

eldavido• 14 years ago

Wall Street sells trust. Trust that, for the one time you want to take a company public in your life, that it won't get screwed up. Trust that they'll repay the billions (trillions?) of commercial paper loaned nightly over the phone, day-to-day, to the commercial banks, which they use to pay interest.

Technology is the last thing Wall Street sells.

rsepassi• 14 years ago

Mark Cuban has touched on what is at the center of why financial regulation is so difficult: the roles, values, and differences of the primary and secondary markets.

All of Wall Street exists to do one thing: connect those with capital to those who want it.

The primary market exists to do what Wall Street is meant to do: a company or other entity wants money, an investment bank connects that company with investors, and investors hand over the money. Wall Street acts as a classic broker, executing the function it was meant to perform (match those with capital to those who want capital). For its services, it takes a cut.[1]

This part of Wall Street - the primary market - works reasonably well and there aren't many complaints about it.[2] In fact, people sometimes complain about the IPO market getting too hot, which really just means that more companies in the real economy are getting money. The biggest ongoing complaints about the primary market are that the big banks charge too much for the capital raises and that they hype up the securities. Neither is a particularly cutting complaint though, nor is either issue crippling in any way to the capital markets.[3]

This brings us to the secondary market - the stock market as most people know it. Most people never participate in the primary market (i.e. in the first sale of securities), but rather in the secondary market. Here's the core question: WHY DOES THE SECONDARY MARKET EXIST?

The secondary market serves a support function to the primary markets. It provides "liquidity" to the primary investors - that is, it gives them a reasonably easy and cheap way to offload their shares should they choose to do so. The idea is that if there's a ready secondary market for the shares, primary market investors will be more willing to participate in deals because they know they can get out quickly and cheaply if they want to, and they'll be willing to pay a higher price for the shares for the same reason. In more technical terms, the secondary market serves to increase the flow of capital to companies and lower the cost of capital for companies.

And this is where all the problems Mark Cuban is citing come in, plus all the problems that financial regulators were trying to deal with in the last regulatory push (Volcker rule, Glass-Steagall, etc.).

The main issue here is that you can't really draw much of a line between "market-making" and short-term trading. Market-making is something most people agree is a good thing - you want a healthy number of market makers competing transaction costs down and providing sufficient liquidity (again, all to serve the health of the primary markets). And short-term trading is something that most people feel is a bad thing - it creates short-term thinking in the markets, which usually flows over into the companies, so you have everybody thinking about the next quarter, which leads people to ignore longer-term and deeper issues. But both market-makers and short-term traders are just buying and selling securities - it looks exactly the same. This is why the Volcker rule is so ineffective. The rule stated that a financial firm could only have a few percent of its capital in "proprietary trading," but every trader at any financial firm knows that most of the trading (and most of the lucrative trading) happens on the market-making desks. Buy a portfolio of illiquid emerging market bonds at 70 cents on the dollar from an investor looking to offload quickly, warehouse it for a few days, and offload at 85 cents. That's market making. And it's also short-term trading. There is no difference. The trader had to make a judgment about whether he would profit on the trade - whether the price of the bonds would hold up until he could offload it, or whether he got it at enough of a discount that even a move against him wouldn't hurt him. He probably thought about whether he could hedge it while he held it or if he could somehow line up a buyer before he even bought it. A high frequency trader is technically doing the exact same thing - just buying and selling; they just get very fancy about figuring out whether they'll profit on the trade: fractional penny arbitrage opportunities, information about where the price is headed in the next half-second, etc.

The best idea I've heard in terms of tackling this specific issue is to alter the tax structure. Mark Cuban advocates this in the form of a 10 cent tax on trades held under 1 hour. Another version I've heard is to levy a similar penalty tax on any capital gains reaped on a trade held less than 3 months (i.e. taxed as income plus a penalty; right now it's just taxed as income), and to move the lowered long-term capital gains tax rate to gains on investments held for more than 2 years (right now, long-term is 1 year). This would certainly discourage short-term trading, but that would mean that it would also make trading slightly more expensive for everybody, which some people think would be a good thing in that it would make people think twice before they traded something, while others argue that it would be a terrible thing because it would hurt the smallest players (individual investors) the hardest - after all, they're the ones who feel trading costs the most in percentage terms (trading costs as a percentage of the amount they're investing).

As a final thought, while all this trading and short-term thinking seems like it hurts us in the long-term, I don't think this is where our energies should be focused in terms of regulation. Trying to get people to stop short-term trading in the market would be like trying to get people to stop going to see movies for all the violence. Sure, it'd be nice if everybody thought like Warren Buffett in the market, and it'd be great if everybody just wanted to watch Stanley Kubrick films. But the important thing is not to get people to be "better," but to ensure they can't cause much damage as they're acting on their impulses. People like violence, but we keep guns away from them. People like short-term trading, so we need to keep LEVERAGE away from them. If you limit leverage, you limit bubbles and busts. It's that simple and that difficult. Bubbles and busts will still happen because people will chase up prices of some securities and then run for the hills once prices falter, but you need to make sure they're just running and not rocketing. Leverage is that rocket - limit it, and you've got the most elegant solution to the major problems of the financial markets. Don't try to enforce good behavior; just limit the power of bad behavior.

[1] Some people complain about the size of the cut that Wall Street takes for these services. The cut is stable and large for 3 reasons: 1. There's an oligopoly at the top. 2. The risks to a failed capital raise are huge, financially and reputationally for the company raising capital, so they usually opt to go for one of the few top players (protecting the oligopoly). 3. Like most large negotiated transactions, there are higher costs of doing business (think cars and houses).

[2] In the primary markets, the area that probably poses the biggest danger to the economy and society as a whole is when it gets into non-plain-vanilla securities, i.e. stocks & bonds work just fine, but derivatives and other instruments (like some asset-backed securities in the last crisis) get a bit more tricky. But I'm going to leave those aside for now since Mark Cuban is mostly addressing trading in the stock market and plain vanilla capital raising.

[3] The costs have been pretty stable for long stretches of time without seemingly barring companies from raising capital or making the capital raise so prohibitively expensive that people don't participate. And on hyping the securities, investors know that there's a financial relationship between the company and the bank, and they're for the most part pretty aware of this and therefore do much of their own research. All the major mutual funds and hedge funds do their own research and know not to rely on bankers (to the point that many portfolio managers ask that the bankers remain silent during meetings with companies that are raising capital until the discussion gets to specific deal terms, and if the company is not raising capital but just meeting with portfolio managers or analysts, the PMs or analysts often don't even allow bankers in the meeting room but ask them to wait out in the lobby or waiting area).

malandrew• 14 years ago

I've read this piece before, but it's dated Sept 21st, 2012. What's up with that?

sowhatquestion• 14 years ago

Some excellent points here, but his conclusions seem to be severely limited by self-interest and/or nostalgia.

"Individual investors and the funds that just invest in stocks and bonds are not going to crash the market."

So what happened in 1929 then?

tptacek8• 14 years ago

It is really easy to convince nerds that Wall Street is fundamentally corrupt because of the exploitation of exotic sounding technology, like "high frequency trading".

The reality is that the vast majority of the damage Wall Street inflicted on the US economy had nothing to do with electronic trading. Until someone invents High Frequency Lawyering, the bulk of the work involved in trancheing collateralized debt instruments is going to be paperwork. Those instruments are traded OTC. While there are electronic markets for some of them, like swaps for blue chip companies, those markets have nothing resembling the volume of the NASDAQ. The '07-'08 crash was caused by evil phone calls more than evil computers.

The other thing you'd want to understand is that prior to electronic trading, Wall Street was crooked as a bucket of fish hooks. Before retail electronic trading, if you (you meaning anyone who didn't work for a trading firm) wanted to buy or sell a stock, you had to find an agent to execute the trade for you. As you can imagine, most people have call to engage an agent very few times a year, but agents work with each other all the time. You got worse prices because your orders would quietly be routed through the channels that secured the most grift for your broker.

There are bad things about HFT; for instance, they create an incentive to route very strong CS talent to Wall Street instead of Google. But before you decide that HFT must clearly be evil because it allows the Goldman Sachs of the world to get better deals than mom and pop stock traders (which, note to mom and pop: don't trade stocks), you should probably have a very good idea what a continuous double auction is, and what a market maker does, and have a good idea of who the "big fish" in HFT are actually preying on. It probably isn't your pension fund.

Evbn3• 14 years ago

Tangent: DMCA takedowns are High Frequency Lawyering.

ChuckMcM• 14 years ago

Sigh, I like Mark Cuban, its fun to watch him on Shark Tank but I don't think he makes a good case here. The financial markets have several ways in which people use and/or exploit them. One of the ways people use the stock market is for investing, one of the ways they use the market is for 'trading' which for all intents is extracting value out of the first (or second) derivative of market trades.

An analogy (weak but serviceable) is that a home town bank is for "saving money", you save your money, you deposit, you write drafts against your deposits that other people can use to make value limited withdrawals. Oh and the people in the bank? They also have a business where they take your deposits and they loan that to people who need money now and can repay it in the future. But to do that they have to do 'magic math' and figure out how likely it is that this borrower will pay it back and they do that with an interest rate. Now the bank, like it has from the beginning of time, is "making money using your money and dealing with people who will pay to borrow it."

Interestingly this exact same works on Wall street and with 'investment banks'. You "invest" (equivlaent to making a deposit) and instead of a chit that says you have $1000 on deposit you get one that says you have ownership of 50 shares of stock in AT&T. Guess what, the bank doesn't just sit on a bunch of stock certificates, they have another business where they let other people use those shares on the agreement they can always get back 50 shares to give to you if you decide you want the certificates to put in a safe deposit box or something. One customer is 'investing' and one (possibly different) customer is 'trading'.

Guess what you can do this with anything of value, and if its something someone consumes you call it "commodities", if its currency you call it "banking", if its stocks and bonds you call it "investing", and if its gossip you call it "journalism."

Mark is smart enough to know this, so why the blog post?

My guess is that a lot of people don't like high-frequency-trading because they can't afford to play. What has happened is that a large holding company, fund, or bank with programmers and computers and data center space near the exchange can easily out trade someone trying to do this through the e-trade Web API. I get how that could be annoying to someone who used to make money that way, tell it to all the folks who used to be able to make a class A game title with a couple of programmers and an artistically inclined person or two.

nirvana2• 14 years ago

My opinion is that Mark Cuban works hard, but he's opinionated most in the areas where he knows the least. He is not an authority on anything, except maybe sports team management. He got lucky selling a shell of company to Yahoo (a fool of a buyer) in the dotcom boom.... but his performance on shark tank and on his blog tell me that, he's confused his luck with talent.

nancyhua• 14 years ago

Agreed. He's entertaining and probably smarter and more focused than 99% of people but his poor arguments make me think he's not a precise thinker and isn't mentally flexible. I wonder if he'd be able to answer this question: What would he have to be persuaded of to change his mind on this topic? (I wonder what everyone including myself would answer to this question.)

I wonder what his motivation is. Is he upset by poor performance in his personal account and wants to blame someone? Does he buy the shockingly confused media hype? Is he threatened by something he incompletely understands? Is he doing it to get even more attention? Is he trying to seem intelligent or gain even more status by jumping on a bandwagon to criticize a popular scapegoat?

wglb3• 14 years ago

I think he knows as much about this subject as he does about managing Dennis Rodman.

scotty79• 14 years ago

I'm pretty sure that's the same business Las Vegas is in.

Tycho• 14 years ago

I read an interesting claim in a book about economics recently: that Wall Street wasn't an industry, but a monopoly.

The argument was that in a normal industry, companies in competition with each other benefit when a competitor goes out of business. Other firms step in and snap up the opportunities. But with Wall Street, the whole network of companies needs a government bail out to stop their wholesale collapse when one company gets into trouble (eg. Bear Stearns, Lehman Brothers). Thus they are not really an industry of competing companies, but should be seen as a single monopolistic entity.

(of course they are filled with competitive people, but think of how departments and employees within the same company compete with each other)

What Business is Wall Street In?

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