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Even worse, Flash Boys buys into the hyperbolic notion that having direct feeds allows one to “legally front-run” ordinary traders. This demonstrates sheer ignorance of how the market works. The fact is, the moment a quote appears on a direct feed, that is a reflection of the fact that the corresponding order has already been accepted into the order book of the exchange. Once that order is displayed in the book, there is no way for any other order to jump in front of it. Anybody who thinks otherwise is extremely confused, and also mistaken.

And what of this magical term “latency arbitrage”? I call it magical because it has a habit of changing its meaning every time somebody seeks to debunk it, making it virtually immune to destruction, like a rapidly mutating virus. I can think of at least three definitions it’s taken on in the past — one related to dark pools pegging their orders to a stale price, another related to an artifact of how slower matching engines convey information about executions and another vague meaning that aims to be a catch-all for any putative ill effect of the speed advantage of direct feeds over consolidated feeds.

One of the more stupid contentions regarding latency arbitrage is that it allows its beneficiaries to see the future. Perhaps, but only if your brain has been addled by too much time travel. You see, the SIP does not reflect the current state of the market, it is delayed. The direct feeds are the most current reflection of the state of the order book. It is in fact true that the present allows you to predict the past, much in the same way that the SIP allows you to predict the 20-minute delayed quotes you can get for free over the Internet. However, it must be said that neither activity entails any economic benefit, because you can’t make money by predicting the past.

It is worth noting that no matter how hard they try, regulators and policy makers cannot eliminate speed advantages in the market. They can, and should, eliminate unfair advantages, such as private or commercial data offerings that are not available on an equitable basis. For example, I believe that it is correct for the government to crack down on early releases of government data, or analyst recommendations. In my view, government data should be subject to rules similar to Reg FD (Fair Disclosure) that governs the dissemination of corporate announcements.

However, direct data feeds are not even remotely in the same category. They are in very widespread use, and they contain information which is necessary for certain players in the market to have, namely the full depth of the order book, which is not contained in the SIP.

What if regulators forced exchanges to deliver their direct feeds for free? Believe it or not, this used to be the case for several exchanges not long ago. Would this result in an elimination of the speed advantage of having direct feeds? Not even close. The reason is that a tremendous amount of skill is required to process this information and use it to generate trading signals. People who can do it faster will be rewarded, and there is not a thing regulators can do about this. Nor should they seek to. When you are taking an exam, speed and correctness both count. The same thing applies in the market.

The conspiracy theorists and self-anointed whistle-blowers of the world will use my remarks to conclude that I am an apologist for the current market structure, and that I am an advocate of the status quo in the stock market. This could not be further from the truth. Like them, I think the market is far too complex and far too fragmented. However, unlike them, I actually understand what is broken and how it should be fixed. Another bout of regulatory upheaval of the sort we had in 2007 is not the answer. The principal beneficiaries of that last upheaval were HFT firms, and the same thing will be true a second time around. Instead, I offer the following relatively modest yet efficacious proposals:

Reform the SIP. Reliability is important, but closing the speed gap versus the direct feeds is even more important. Countless conspiracy theories about the market exist solely because of this discrepancy, resulting in the erosion of investor confidence. It’s overdue that this gap be closed to the maximum extent possible.

Reform the order protection rule. The ban on locked markets in Rule 611 of Reg NMS is extremely harmful to the market, and is the principal source of all the unnecessary complexity with which we are faced. If it were lifted, quote stuffing would virtually disappear, the need for speedy routes between market centers would be dramatically curtailed, exotic order types would be completely and utterly useless, the rules of trading would be massively simplified and understandable again by the majority of people, spreads would tighten, and volume would return to the lit markets from dark pools. Even payment for order flow would come under pressure. In other words, virtually every negative aspect of today’s markets would be ameliorated or outright cured. The reasons are complex but straightforward, and I’ve written on them for Institutional Investor previously. If there is demand from readers, I am happy to proffer a more detailed explanation.

Reform tiered rebates. It is flat-out unfair that exchanges are allowed to offer higher rebates to large traders than to small traders. I say this as someone who benefits from the highest tier of rebates at every exchange, so I’m not talking my book. There should be one rate for everyone, that’s what is fair.

Examine retail brokerage commissions and practices. Brokerage commissions for institutional investors have plummeted by an order of magnitude since the advent of HFT. However, retail investors are still paying basically the same thing as they were in 2007. What’s the deal with that, Chuck Schwab? How about passing on some of your savings to the little guy? And while we’re at it, the fairness of paying brokers for their order flow should be revisited.

Manoj Narang is the founder and CEO of Tradeworx.

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