The Reason a Billionaire Hedge Fund Manager Is Fighting High Speed Trading

How one investor's technological optimization becomes another's profit margin interference. JL

Alexander Osipovich reports in the Wall Street Journal:

Big investors say HFT erodes their profits. That’s because prices often drop when a large player is selling, or rise when the large player is buying—a phenomenon called “slippage” that’s often blamed on speedy traders. Slippage is “a multibillion-dollar-a-year problem” for the hedge-fund industry. Billionaire Steven A. Cohen is backing a startup that aims to prevent high-frequency traders from eating away at the profits of stock-pickers like himself.
Billionaire Steven A. Cohen is backing a startup that aims to prevent high-frequency traders from eating away at the profits of stock-pickers like himself.
The venture-capital arm of Mr. Cohen’s firm, Point72 Asset Management LP, was the first investor in Imperative Execution Inc., said representatives of the two firms. They didn’t specify the investment size. The startup is set to launch a new “dark pool” trading platform designed to counter the impact of certain high-speed trading strategies.
High-frequency trading, or HFT, firms use computers to buy and sell stocks in the blink of an eye. They seek to profit from fleeting price moves or inefficiencies in the machinery of financial markets, rather than analysis of companies’ financials or economic trends.

Many big investors say HFT erodes their profits. That’s because prices often drop when a large player is selling, or rise when the large player is buying—a phenomenon called “slippage” that’s often blamed on speedy traders.
Slippage is “a multibillion-dollar-a-year problem” for the hedge-fund industry, said Matthew Granade, managing partner of Point72 Ventures.
Advocates of HFT say criticism of electronic trading is overblown. They say it has actually reduced costs for investors by reducing the so-called “bid-ask spread,” or the difference between the buying and selling price of stocks.
Imperative founder and Chief Executive Roman Ginis previously worked as a quantitative trader for Mr. Cohen’s firm, applying statistical models to trade stocks. He said he waged a daily battle to prevent slippage from hurting his profits.
Imperative’s trading venue, called IntelligentCross, will be a dark pool—a type of trading platform subject to lighter regulation than exchanges.
Dark pools, unlike exchanges, generally don’t broadcast the prices at which traders are willing to buy or sell stocks. That makes them attractive for big investors looking to execute large trades without signaling their intentions to the market. For startups like Imperative, it’s also much easier to launch a new dark pool than a new exchange, due to the simpler approval process.
The Imperative platform won approval from the Securities and Exchange Commission earlier this year. The Stamford, Conn.-based firm, which has 10 employees, aims to launch the platform in May.
The launch comes as Mr. Cohen has been working to clean up his image. His prior company, SAC Capital Advisors LP, pleaded guilty to insider trading in 2013. Mr. Cohen was never criminally charged. He later reached a deal with regulators that barred him from managing outside money for two years.
After that ban expired earlier this year, Point72 opened to outside investors. But Mr. Cohen’s return was roiled by a February lawsuit by a female employee accusing Point72 of discrimination. The firm has said it “emphatically denies” the allegations. The lawsuit is pending.
The venture arm of Point72 has invested in other financial-technology companies such as Quantopian, a do-it-yourself online platform for quants, and SAY, which aims to help smaller shareholders use their proxy voting rights.
IntelligentCross could undermine IEX Group Inc., an exchange that has also battled HFT on behalf of traditional investors. Founded in 2012, IEX has struggled to be more than a niche player, handling 2.3% of U.S. stock volume in March, data shows.
“IEX has not fulfilled its vision of solving the slippage problem for stocks,” said Ian Sigalow, a partner at Greycroft LLC, a venture-capital firm that has also invested in Imperative.
An IEX spokesman responded: “Public data and industry reports continue to verify IEX’s success in combating predatory HFT, and we welcome others to join us in the fight to protect investors.” He pointed to an October report from Jefferies that showed IEX beats other exchanges on measures of slippage.
Imperative is entering a crowded market with about a dozen exchanges and more than 30 other dark pools. To win business, it must convince brokers to route their customers’ orders to IntelligentCross. Imperative says it has already convinced some big investment banks to connect. It didn’t name them, but said it would list them on its website once it got their permission.
The new venue will use a variety of tricks to foil fast traders. A key feature is that it only executes trades at discrete points in time, rather than continuously, the way exchanges work. The length of the intervals varies randomly, which Imperative says will keep the speedy traders from figuring out a pattern and gaming the platform’s design.
The idea of “non-continuous” trading venues isn’t new. But Imperative says it has added a new element by using artificial intelligence, or AI. Its systems will monitor for whether trades on IntelligentCross are causing stock prices to move, and adjust the length of its intervals to minimize such slippage, using AI-powered software.
Mr. Ginis, who has a PhD in computer science from the California Institute of Technology, previously worked for Cubist Systematic Strategies, the quant-trading business of Point72. He said he got the idea for IntelligentCross while working for Cubist as a “medium-frequency” trader—with algorithms that involved holding stocks for a day or two.
Like for many traders, slippage was a day-to-day headache for him.
“No one’s found the silver bullet to solve this problem,” Mr. Ginis said. “We’ve found a new approach that we believe will work better over time.”