Ellie K's Journal: The mysterious RT Leuchtkafer and HFT

Leuchtkafer means firefly in German.

Who is Leuchtkafer?

In April 2010, RT Leuchtkafer sent a particularly articulate letter to the U.S. Securities and Exchange Commission in response to an SEC concept release inviting public comment on the structure of the stock market. His greatest ire was directed at the electronic data feeds that exchanges provide to high-frequency trading (HFT) firms. These feeds contain real-time market information, including details about any massive orders placed by institutional firms, such as mutual funds. Having access to this data and flow gives a huge advantage over all other stock market participants who don't have the same level of access to these feeds. Among other things, Leuchtkafer observed in his first communique to the SEC:

A classic short-term strategy is to sniff out an elephant and trade ahead of it. That is front-running if you are a fiduciary to the elephant but just good trading if you are not, or so we suppose.

The sad fate of Kirilenko's research article
Leuchtkafer's second comment was on 31 October 2010, following release of "Findings Regarding the Market Events of May 6, 2010", a joint report by the SEC and CFTC. Leuchtkafer's third comment was in February 2011. It focused on a highly anticipated research study by CFTC economist Andrei Kirilenko, whose purpose was to quantitatively examine the impact of high frequency market makers. Kirilenko found that HFT was causally related to structural instability, crashes and liquidity crises, toxic quotes, impaired price discovery in public markets and greater uncertainty about any given order's likely effect on prices. Neoliberal economist Bradford Delong's blog readers included the following reaction after reading Leuchtkafer's third comment to the SEC on the adverse effect of positive feedback trading on financial markets:

Among the good reasons for reform was that innovation was being strangled by entrenched interests. The assumption is that innovation is good in finance too. I think the weight of evidence is overwhelming that we need to strangle further financial innovation. What good has it done in the past 30 years? Leuchtkafer thinks that no one wants to go back to the old days. I do. I would be glad to give brokers and market makers rents in exchange for more stable markets.

Kirilenko's paper could have been acted on by regulators, and used as an irrefutable empirical justification for reforming the activity of high frequency market makers. Instead, the paper was suppressed following protest to the SEC and a lawsuit filed by a futures industry trade group and affiliated lobbyists.

Red herrings
In 2012, Wall Street Journal reporter and author Scott Patterson objected to speed and/or program trading because it involved:

complex multi-legged orders called bracketed orders or conditional orders with odd names like long condor, short iron butterfly, and married call, with complex sentence structures, such as to buy this and to sell that, but only if this other thing happens, and also to cancel a certain part of the order otherwise.

In fact, these sort of trades, which describe synthetic or hedged options positions, have been in use for decades prior to the arrival of HFT in 2006. They are not the problem. They would remain even if HFT were banned tomorrow, e.g. by returning to fractional rather than current standards decimal pricing for listed and exchange traded equities!

More recently, debate about IEX, the start-up trading venue operator that promised to protect investors from predatory trading activity and mentioned by Michael Lewis in his new book, has been caught up in trade counting problems of its own:

Even trading volume on the IEX exchange, which is trumpeted as creating institutional fairness in the Michael Lewis book, Flash Boys about the topic, is now made up of roughly 50 percent high-frequency traders.