We need a tax on HFT

Friday, July 31, 2015

High Frequency Trading began in 1989, according to a June 6, 2013, Bloomberg Businessweek article by Matthew Phillips, "High Frequency Trading's Rise and Fall."

Despite the title of the article and the slight reduction in the percentage of stock market trades that are HFT trades, the HFT trades still account for a significant portion of the total stock trades and is still a blight on the world of finance.

According to the article, Steve Swanson, a recent graduate of the College of Charleston, spent most of his time in the summer of 1989 in the garage of his college statistics professor, Jim Hawkes, programming algorithms for what would become the world's first high-frequency trading firm, Automated Trading Desk. The article stated, "Hawkes had hit on an idea to make money on the stock market using predictive formulas designed by his friend David Whitcomb, who taught finance at Rutgers University. It was Swanson's job to turn Whitcomb's formulas into computer code. By tapping market data beamed in through a satellite dish bolted to the roof of Hawkes' garage, the system could predict stock prices 30 to 60 seconds into the future and automatically jump in and out of trades. They named it BORG, which stood for Brokered Order Routing Gateway. Among the BORG's first prey were the market makers on the floors of the exchanges, who manually posted offers to buy and sell stocks with handwritten tickets. Not only did ATD have a better idea of where prices were headed, it executed trades within one second - snail's pace by today's standards, but far faster than what anyone else was doing then."

Now there are many high frequency traders, typically averaging only a fraction of a cent in profit on each share of stock bought and sold, but they trade massive amounts, tens of millions or hundreds of millions, of stocks every business day.

For more than a decade, there have been calls to eliminate HFT as a practice that is as unethical and market-distorting as insider trading. In a sense, it is insider training.

A simple solution would be to tax each sale of a share of stock one penny. This would not be a one percent tax, assuming that stocks sell for more than $1 a share.

The impact of such a tax on legitimate investors would be minimal.