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What If HFT Is Actually Good For The Market? at Trader’s Narrative

What If HFT Is Actually Good For The Market?

High Frequency Trading is not only the fastest growing subset of trading, it is equally lucrative and controversial. The public perception of HFT is incredibly negative with most people believing that it has a negative effect on price discovery, liquidity and that plainly put, it isn’t fair.

That public perception may need to be adjusted according to this recent research by finance PhD candidate, Jonathan Brogaard (Kellogg). The paper looks at the effect of HFT on equity markets and through analysing the strategies used by these firms it considers their profitability, impact on market liquidity and volatility.

There is evidence that high frequency trading contributes to price discovery and liquidity. There is also evidence that it has a minimal impact on volatility and may even reduce it. There is also no evidence that they engage in front-running. HFT demand for liquidity (42.7%) is slightly higher than their supply of liquidity (41.1%) and they provide the inside quote about 65% of the time.

If HFT’s were not market participants, the average lot trade (100 shares) would have an adverse price movement of $0.013 more than it does currently (for trades of 1000 shares, the adverse price movement would be $0.056). Usually they engage in counter-trend strategies, especially when demanding liquidity.

I don’t think this settles the question once and for all. But we need this sort of rational discussion and research much more than anecdotal evidence and emotional outbursts. Whether you like it or not, High Frequency Trading is here to stay because it provides lucrative returns for everyone involved. The 26 HFT firms in the study earned $3 billion annually. The exchanges that receive collocation fees are also benefiting. And let’s not forget that for all the controversy, there is nothing illegal about HFT.

So the real question is, given the reality that the market structure has changed, how are you going to adapt? The SEC is currently engaged in a thorough study of the May 6th flash crash and will be releasing the results later this month. While “quote stuffing” got a lot of attention recently as a potential cause, based on preliminary statements from chairperson Schapiro, it doesn’t look like the SEC is following that lead.

The only significant change to market structure was the end of stub quotes on both Nasdaq and the NYSE. These are minimum and maximum quotes provided by market-makers in order to technically qualify as providing a market in a stock. This change was made to prevent the new individual circuit breakers from being triggered.

Here is the full study referenced above:

Source: Jonathan Brogaard

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One Response to “What If HFT Is Actually Good For The Market?”  

  1. 1 Wes

    Of course the HFT programs front-run. Anyone or anything saying different is engaging in whitewash.

    It’s quite easy to detect in pre or after market trading. Let’s say you want 250 shares of a security and 100 are available at $10.00 and 150 are available at $10.01. You enter a limit order for 250 at $10.01 to fill the entire order with a single brokerage fee.

    In the old days, you would have bought 100 at $10 and 150 at $10.01. Not anymore. Immediately on placing the order you will see a bot program buy the 100 at $10.00 and resell it to you at $10.01.

    Now this example is trivial, but I’ve had this practice cost me as much as $25 on a single trade.

    I’d like to see it outlawed!

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