The financial services industry is well-known for its complex terminology, incomprehensible to anyone outside the sector – perhaps even to some active in it. Exchange-traded markets are especially loaded with jargon. Words like dark pools, high-frequency trading, co-location and latency arbitrage are commonly used by people in the business, making it difficult for outsiders to understand what they do. Then there are all the acronyms that market professionals use to describe the avalanche of new regulations—acronyms like EMIR, MiFID, MiFIR and MAR. As such, it is hardly surprising that those reading and writing about financial services may struggle to navigate its linguistic idiosyncrasies…
To take a couple of recent hot topics, Eric Schneiderman, the Attorney General for the state of New York, has recently given some high-profile speeches on financial markets and high frequency trading. Schneiderman is an experienced and effective lawyer with a long list of successful prosecutions, but his use of the term “risk” gives the impression that he thinks high frequency traders are somehow guaranteed not to lose money. In one recent speech, he claimed that exchanges provide certain services that give some of their clients an unfair advantage over others.
“Each of these services offers clients a timing advantage – often in milliseconds – that allows high-frequency traders to make rapid and often risk-free trades before the rest of the market can react,” Schneiderman said in March.
No one entering the financial markets can guarantee they will make money on their transactions, no matter how fast data is transmitted. All that they can do is to assess the risks they are taking, and try to manage those risks: the greater the risk a participant takes, the greater the return (revenue) they expect to receive as a result. High frequency traders make trades that involve large numbers of low level risks, and therefore small profits and losses. By the laws of probability with large numbers they make a profit on just over 50% of trades, and lose money on slightly less than 50% of all trades (you can read more about this here). If high frequency trading were risk-free, then they would be making money on around 100% of trades, not around 50%. In addition, low risk trading is better for the quality of the financial markets than high risk trading because it creates smaller price movements and less potential volatility than high risk trading.
Similarly, Michael Lewis stirred up a lot of confusion when he applied the term “front-running” in his book, Flash Boys, and in subsequent interviews, leading to a plethora of articles following suit:
“One reason for such a move is that sales on the more transparent public exchanges risk falling prey to “front-running” by high-frequency traders. The problem is that the “Flash Boys” — the author Michael Lewis’s nickname for such traders — can gain information before others who might want in on the deal, and can use that information in milliseconds to change the value of a trade to their advantage.” - New York Times
Front-running is a legal term, referring to a situation in which a broker acting on behalf of a client intentionally trades ahead of that client order for his own account. In other words, that individual has privileged information about trades that are due to be executed, because of his responsibility to execute client orders, and uses this additional information for his own benefit. Speed of trade execution is irrelevant when discussing front-running. Front-running is an illegal activity on the financial markets and is subject to stringent regulations: FIA EPTA does not condone anyone participating in activity of this nature. In any case, proprietary trading firms by definition do not trade on behalf of clients, so they do not have access to privileged information about client trades.
At FIA EPTA we’re aware that these kinds of confusion cannot be conducive to discussing the future of trading (or the present and past for that matter), and we hope to play a part in reducing it. Our goal is to offer anyone discussing the financial markets (wherever these discussions take place, and whoever is participating) an opportunity to understand the terminology they’re surrounded by and apply it correctly. The idea of ‘us’ and ‘them’ is outdated, and the financial markets need to move on.
While it might take several years to write a comprehensive glossary of terminology used throughout the entire financial services industry, we’ve tried to shed some light on the language used around the secondary trading markets in particular, by producing a short glossary of the most common terms used in electronic trading.
View the electronic trading glossary.
The views expressed in this blog post are the personal opinions of the author and do not necessarily reflect the official policies or positions of the FIA European Principal Traders Association or the Futures Industry Association.
