Bear raids, naked shorts, and high frequency trading

High frequency trading (HFT) isn't toxic by itself.  Ironically, it is the non-trades which distort markets. These algorithms destroy market pricing discovery mechanisms when they are utilized as empty millisecond bids/offers to manipulate prices in the intended direction.

For example, imagine if you were a trader, and all you saw were huge sell orders lined up on your computer screen.  Even if no one hits the offers, enough panicked sellers would hit all the bids, driving down prices.  Never mind that the sell orders were never intended to be executed--they were merely submitted to scare traders (i.e. buyers) out of their positions.

It's analogous to the mafia coming in and putting up For Sale signs on every front law in your neighborhood.  Pretty soon, all buyers would be scared off, and panicked sellers wanting out would sell first before their neighbors do, causing prices to fall further.  Shoot first--ask questions later.

And this is all done despite the mafia not owning a single home in the neighborhood--hence, the phrase "naked sale."  In this hypothetical example, the mafia never owned the homes, but the pervasive presence of the For Sale signs can induce a massive sell-off of homes in the neighborhood--at lower and lower prices.  Ergo, all the homeowners just experienced a bear raid, without knowing what hit them.

In the real world, since real estate is illiquid, transactions normally take weeks and months to consummate.  However, in an era of electronic equities trading, these bear raids can literally occur in a few seconds.  Hedge funds and institutions game the system by placing their servers closer to the electronic exchanges, giving them millisecond competitive advantages.

Line up enough sell orders at varying price points, and a collusion of several miscreants can induce a bear raid of massive proportions.  A naked short can crash the asset in question, and after prices plummet, can scoop up said asset at much lower prices before their competitors can.  In other words, by being more nimble, they make money on the way down--and on the way up with their manipulations.

It's an unfair advantage which the big players have opportunistically exploited, albeit at the expense of smaller investors who rightfully have abandoned the markets.  No one wants to gamble in a casino which is rigged.  With many investors exiting the rigged markets, it has now become a war between battling algorithms, where the sharks no longer have guppies to feed off, but are now devouring each other.

With recent investigations of Barclays rigging the LIBOR and other interest rate markets, their confessional includes pointing the finger at their accomplices in capital markets, including other banks, central banks, and governments.  The house of cards is crumbling, and with it being a glass house, all the perps are being exposed in their nakedness.