Last week, it was big news when the four Wall Street firms (Goldman, Citi, Bank of America and JP Morgan) announced that they had gone the entire first quarter of 2010 without a down day on their trading desks. Look Mom, no losses. Some were skeptical. Called Wall Street a fixed game. Well turns out a perfect quarter is not such a great achievement afterall. From Monday's New York Times article on high frequency trading this tidbit about a shop in Kansas City, called TradeBot:
Over the last decade, these high-tech operators have become sort of a shadow Wall Street "” from New Jersey to Kansas City, from Texas to Chicago. Depending on whose estimates you believe, high-frequency traders account for 40 to 70 percent of all trading on every stock market in the country. Some of the biggest players trade more than a billion shares a day.
These are short-term bets. Very short. The founder of Tradebot, in Kansas City, Mo., told students in 2008 that his firm typically held stocks for 11 seconds. Tradebot, one of the biggest high-frequency traders around, had not had a losing day in four years, he said.
Ka-Blam. Take that Wall Street. TradeBot sees your quarter and raises you 15. TradeBot's profit run also suggests that last quarter's trading results at Wall Street firms might be less of a fluke and more indicative of a strategy shift. Here's why:
So who or what is TradeBot the firm that appears to be kicking Wall Street's bottum in trading. The outfit is run by a guy who briefly was taking on the Nasdaq. His name is Dave Cummings and this is from a 2007 profile in Forbes:
Cummings has held a grudge, a vendetta even, against Nasdaq ever since 2005, when the bigger exchange paid $1.1 billion for two ECNs, Brut and Inet, both of which carried trades emanating from Cummings' other business, a North Kansas City brokerage firm called Tradebot Systems. He still owns 100% of Tradebot but no longer manages the firm. (He claims that Bats and Tradebot extend no preferential treatment to each other.) The acquisitions by Nasdaq erased two possible competitors, and soon after that Nasdaq eliminated the low fee structures at the ECNs that had once attracted broker-dealers.
Cummings has since left BATS the ECN he formed to take on the Nasdaq, and is now back at TradeBot full-time. The nearly 1000 point, 16-minute market crash last week has put a lot of attention on high frequency traders. And Cummings is one of the biggest. Now it seems Wall Street firms want in on that business.
There are two types of trading. One is when you pick a stock or bond and buy and sell it because you think it is going up or down. The second is when you just act as a middle man buying a stock or bond because you know someone else wants to buy it from you. The second activity is market making. It's less profitable, but it is reliably profitable. High frequency trading is just that--market making. So if Wall Street firms are doing more of that kind of trading--more high speed, less proprietary--than their perfect quarters are less impressive, and less suspicious, than the original headlines suggest, as TradeBot's run, which is all high frequency, suggests.
And that's what the evidence seems to show. At three of the four firms that recorded a profit on trading in everyday of the first quarter, their so-called Value-at-Risk measures, which tracks how much a firm can lose in one day, dropped. Goldman's VaR was $161 million in the first quarter of 2010, down from $240 a year ago. JP Morgan's dropped to $82 million from $213 million in 2009. That probably means these firms were doing more market making, which is less risky, and less prop. trading. The one exception is Bank of America, which saw its VaR rise slightly, even as it recorded its perfect quarter. So Kudos Bank of America. The rest of Wall Street: We'll see you in four years.
Economists are a surgeons with an excellent scalpel and a rough-edged lancet, who operates beautifully on the dead and tortures the living.
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