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How to kill high-frequency trading

Brendan Bannon | Bloomberg | Getty Images

I just want part of the country: S&P futures, which had been down all morning, spiked over 10 points just prior to 8 a.m. ET, as Vladimir Putin said speculation that Russia wants more than just Crimea is incorrect.

It didn't move futures, but February Housing Starts were slightly better than expected, and there were significant upward revisions (909,000 from 880,000) in January.

Elsewhere:

Alibaba confirmed it is listing in New York, not Hong Kong. This is a huge win for the U.S., but it's not necessarily the kind of win we want. The U.S. won because the other guy (Hong Kong) decided it didn't want to play ball. They beat themselves by not being flexible. Hong Kong does not like the partnership structure that Alibaba has; they want "one shareholder, one vote." Here a small group of shareholders can effectively control the board. Here you can also have super-voting shares of stock that allow effective control with a small group of people.

(Read more: Alibaba picks US for IPO)

New York Attorney General Eric Schneiderman, in a speech this morning, has taken aim at high-frequency traders. In his speech, he notes that his office was instrumental in getting Thomson Reuters to stop allowing high frequency and other traders to pay a premium for a two-second advance look at consumer sentiment numbers. Mr. Schneiderman also notes that his office was instrumental in getting Business Wire and Market wired to stop selling information directly to high-frequency firms, which allowed them to get information a split second earlier than investors relying on news sources like Bloomberg or Dow Jones.

Mr. Schneiderman is now focusing in on colocation, which allows any subscriber to locate its computer services within the exchanges' data centers. Mr. Schneiderman claims this gives them an unfair advantage.

(Read more: New York attorney general calls for curbs on traders)

Here's a question: How many traders have access to these colocation services? Do pension funds? Do mutual funds? I think a review would find that most firms--including the firms that cater to discount brokers like Charles Schwab and TD Ameritrade--are colocated.

Mr. Schneiderman also says this is forcing many traders into dark pools to conceal their orders.

But he is very short on specifics on what he wants. He supports proposals to put a "speed bump" in place, which would prioritize price over speed.

I'm all in favor of price over speed--it's a principal of modern trading, after all, but a "speed bump" will not do anything. If you put in a rule that says, for example, that everyone has to wait one second between the time a trade is entered and the time it is executed, than a machine that can execute a trade after one second in, say 25 microseconds will still have an advantage over a human, even with the speed bump.

Isn't that obvious? If you really want to kill or cripple high-frequency trading, here are two suggestions:

  1. Institute a "cancellation tax" for anyone putting in excessive bids and offers, that seem designed to "fake out" the competition, or
  2. Eliminate payment for order flow, wherein exchanges pay traders to "make" liquidity (post bids and offers) and charge traders who "take" liquidity (those who hit the bids and offers).

It might seem right to institute a "cancellation tax" but the devil is in the details, in determining just how many bids and offers constitute some kind of market abuse.

As for payment for order flow, many high-frequency traders rely on the rebates they get from posting bids and offers as a crucial part of their business model. Without the modest "extra" they get from the rebates, many strategies become unprofitable.

Payment for order flow is a cornerstone of the modern market; it has been around for more than a decade. Everyone gets paid or charged: When you put an order in through TD Ameritrade or Schwab or any discount broker, that broker is "selling" the order flow to a firm like Knight Capital or UBS or Citigroup that takes all those orders and "internalizes" them. Simply put, they try to match those orders against others they have in their inventory. It only goes to the exchanges if there is no internal match.

That's why you can make a trade for only $7.99 with a discount broker: Someone is subsidizing that trade for you.

Jeff Sprecher, CEO of IntercontinentalExchange, which owns the NYSE, has said he would like to see a debate on why we need payment for order flow.

I welcome that debate, but Mr. Sprecher is facing very entrenched interests on all sides.

But be very careful what you wish for. Both of these proposals I've made come with an obvious disadvantage: They would both likely dramatically cut trading volumes. Would this matter? Would it increase, not decrease, volatility? Would it cause more harm than good? That is debatable. But it would certainly change the dynamic of trading.

Hertz Global (HTZ) reported earnings and revenues below expectations, and gave 2014 earnings guidance well below expectations: $1.70-$2.00 versus $2.07 consensus. Revenue guidance of $11.4 to $11.7, however, is within consensus of $11.6 billion.


By CNBC's Bob Pisani

  • A CNBC reporter since 1990, Bob Pisani covers Wall Street from the floor of the New York Stock Exchange.

Wall Street