MILLBURN, N.J. (TheStreet) -- Algorithmic and high-frequency trading has been a destructive force in the stock market. As we have seen in just the past few trading sessions, these trading strategies and their execution platforms can create excessive dislocations both to the upside and downside in a very rapid manner and short time frame. I strongly believe that these programs add zero value to the individual investor and may extract wealth from the hundreds of millions of people whose investments and pension are invested in the equity markets.With that in mind, I want to point you to the May 2010 issue of Traders Magazine . The issue was devoted to crossing network and dark pools. By extension, high-frequency and algorithmic trading was also covered in the issue. Included in the issue was the following letter from the publisher, Kenneth Heath:
"Welcome to Traders Magazine's 2010 Special Report on Crossing Networks/Dark Pools. Crossing networks and dark pools are the subject of debate amongst regulators both in the United States and Europe. Despite any controversial aspects, these modern-day forms of non-displayed liquidity have undisputedly become essential components of the equity markets as traders seek to source liquidity and achieve best execution. "Please read on to learn about leading firms' strategies for crossing networks and dark pools and how their technologies and trading methods impact both the buyside and sellside. In addition, these firms share how they can help improve execution quality while safeguarding client orders in today's challenging, fragmented market. "We welcome your feedback on this publication. If you have any comments or questions, or if you have suggestions for additional supplemental topics, please feel free to call or email me."I am taking up Heath's request for comments or questions, using this article as the forum for my opinion. First, let me say that the May 2010 issue of Traders Magazine was tantamount to an advertising circular for the service providers who offer crossing networks, algorithmic and high-frequency trading platforms and dark pool executions. Second, the magazine issue was very one-sided. If you state upfront that these are controversial products and services, don't you owe your readers both sides of the controversy? How does the retail brokerage industry feel about these products? What do the SEC and the UK's FSA think about these issues? What is the opinion of the NYSE and other SROs? Third, I contest that "these modern-day forms of non-displayed liquidity have undisputedly become essential components." I would not say that they are essential. The markets functioned properly before the introduction of algorithmic trading and dark pools. In fact, I think that the contrary is true. These trading products and services have exacerbated volatility and drained individual stock liquidity. In the process, the individual investor is being hurt. How have dark pools, high-frequency trading and algorithmic trading helped out the typical municipal employees' retirement plan?
"SuperX is Deutsche Bank's dark liquidity seeking algorithm. In a world of incredibly complex and rapidly evolving electronic markets, you need a partner with the smartest algorithm to access the deepest pools of liquidity. Your executions need to balance the efficiency of extracting liquidity while controlling market impact and maintaining anonymity. SuperX is dark trading made intelligent, bringing you a quantitatively engineered Smart Allocation Model and anti-gaming measures designed to prevent information leakage and systematic adverse selection for smarter liquidity. Now there's a more intelligent choice for dark liquidity, Deutsche Bank."We have product providers who are in an arms race to provide traders with the most sophisticated money extraction machines. We are creating products to siphon off wealth from shareholders and move them to active traders. In the process, the liquidity that is purported to be created is removing liquidity from the system as more individual and traditional institutional investors are becoming distrustful of an equity marketplace no longer controlled by shareholders but by Space Odyssey HAL-like machines, which attempted to replace "human error" with computers. So this raises the question: How can we inoculate ourselves against the adverse consequences of high-frequency, algorithmic and dark pool trading? Here are a few suggestions. 1. Increase minimum trading increments to 5 cents per share. The lower the incremental spread on stock trading, the higher we should expect volatility to manifest itself. Why do we need penny increments as we have now? Why do we need the half-penny increments that the SEC is currently considering ? The markets worked just fine with eighths and sixteenths. Let's try something in between: How about nickel increments? We broke the system by going from sixteenths, or 6.25 cents, to pennies. Try a nickel. I am perfectly happy transacting at nickel spreads. It is irrelevant to investors. Transacting at 5-cent increments might get us back to normal -- and we certainly don't have normal right now. It would also eliminate the devastating effect of high frequency algorithmic computer trading. 2. I am not a pro-tax guy. For the record, I am a proponent of lower taxes and supply-side economics, especially the Laffer Curve. However, there is wiggle room to consider sin taxes, such as for cigarettes and liquor. I would consider high-frequency trading as a sin upon the individual investor. So while I abhor increased taxes, I think there is room for a securities transaction tax on stocks in the U.S., such as that proposed by Nobel Laureate James Tobin for currencies. This tax was proposed to combat market volatility. Of course, a Tobin-like tax would be hated by the sell-side vendors who would lose volume, but it would protect buy-side individual investors who are being cheated by the high-frequency traders. This tax can be graduated so as not to impact the individual at-home or small-business day-trader or investor.