The following is a conversation two people were having about #HighFrequencyTrading.

J: I read this NY Times op-ed by David Swensen. As a personal investor, I feel scared about placing trades. From what he wrote about High Frequency Trading firms, I feel like a deer caught in headlights.

G: I have been in HFT for more than ten years J. I understand what you are saying. I get it, but I feel it is a matter of perception. If you feel like HFTs are making money every time you place a trade, you are probably right.

However, Google is probably making money from ads every time you search. Facebook is making money every time you post a picture. That should feel equally preposterous.

In fact, Google and Facebook probably make a hundred times more money than HFTs.

J: What exactly is an HFT?

G: An HFT (high-frequency-trading) firm starts the day without any stocks in its portfolio and ends the day without any stocks. During the day they trade a lot. They trade so much that nowadays that 4/5th of all shares traded are traded by HFTs. Another interesting fact is that an absurdly high number, like ninety nine out of every hundred orders are placed by HFTs but they end up canceling most of their orders. What are they trying to do? They are trying to sniff out what the real investors want to do and they are trying to position themselves to make money from this. Like say, on Friday Jan 22nd 2016, when everybody was buying, HFTs were buying first and trying to sell to others later. The fact is that a lot of people buy for very simple reasons that can be guessed easily. Like if the market went up on Friday, it is easy to guess that investors would have bought more Apple stocks than they would have sold. HFTs make money from these simple guesses.

J: So why do we need these HFTs, if at all?

G: Look HFTs are in the business of matching buyers and sellers. It is a perfectly reasonable aim to “improve” equity markets such that long-term buyers and sellers can be matched without the need of intermediaries. The problem is that long-term buyers and sellers don’t decide on their actions at the same second, but they want to get done with their trades as soon as they have thought of it. If I want to buy a stock now, and no one but an HFT is willing it to sell to me, I have to trade with them. I don’t have the sort of systems that they have built. Of course they are going to skim off the top. It’s like any other tech business.

We don’t ask Apple to charge us the cost of goods in an iPhone or Google to pay us a cut of the ad money they make from our searches.

J: Just another consumer tech business?

G: Yes. In fact just like any other successful tech business, its success today is built on two principles, asymmetric information and monopolistic pricing.

J: Let me ask you this … these other tech businesses have brought a lot of innovation. What have HFTs done?

G: This is a great question. This is perhaps the question that most people don’t know. HFTs are super awesome at technology, infrastructure, high performance systems and machine learning. They are so awesome that they would probably blow a lot of other tech firms out of the water, were they to shift to bidding for online ads or something like that. For example, Jace Kohlmeier went on to head Data Science at Khan Academy after a long spell in HFT.

J: Is there anything that can be done to “unrig stock markets”?

G: That, as Dr. Alfred Lanning would say, is the right question.

Yes of course. Let me point out three stylized facts:

Investors have different time horizons over which they want to hold the trade.

For some unscientific reason, they all want to “get done” with their trading in the blink of an eye.

Prices move up and down, but in average they just move sideways. In technical terms, the expected value of future price movement is (almost) zero.

Now, can you tell me what can we do to "unrig stock markets"?