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Short-Sale Ban Chases High-Frequency Traders From the Market
Traders Magazine Online News, September 29, 2008
Some market volume may be missing in action. The Securities and Exchange Commission's temporary ban on short sales in financial stocks appears to have chased liquidity out of the market, according to several broker-dealers.
Last week's volume was high by historical standards, but some think it was suppressed by the ban on short-selling that went into effect 10 days ago, on Friday, September 19. "The high-frequency players are turned off right now because of the SEC ban on short-selling in financial stocks," said Dan Mathisson, head of Advanced Execution Services at Credit Suisse. "On days like these, with so much news on the tape, I'd have thought we'd see 13 billion or 14 billion shares." Mathisson and the others quoted in this story spoke at a Traders Magazine conference last Wednesday.
Consolidated equity volume hit all-time daily records in the two days running up to the ban, reaching 18.7 billion shares on September 18. Volume was just under 16 billion on the 19th, when the ban was implemented. Volume fell to 8.8 billion shares last Monday and Tuesday and 8 billion on Wednesday. It skipped up to 9.4 billion shares on Thursday and dropped back to 8.8 billion on Friday. Average daily volume in the first half of the year was under 8 billion shares, compared to 5.8 billion shares in the year-earlier period.
Joe Gawronski, president and chief operating officer at Rosenblatt Securities, estimates that high-frequency trading in recent months has represented half to two-thirds of the traded volume in the U.S. "High-frequency traders are the gorilla in the market," he said. However, he added, the gorilla's footprint shrank in the days after the SEC's short-selling ban went into effect.
Unlike other market participants, registered market makers, including big high-frequency trading firms like GETCO and Citadel, are allowed to short financial stocks as long as it's done to hedge their market-making activities in those names. The SEC ban currently expires on October 2, although it is expected to be extended past that date.
However, the ban sidelined a host of hedge funds and proprietary trading shops that provided one- or two-sided liquidity to the markets. Many firms with high-frequency trading strategies aren't registered as market makers and aren't brokers. As a result, they can't short financial stocks. Statistical arbitrage strategies, whose continuous trading also generates a lot of liquidity, are in the same boat. Credit Suisse's Mathisson said some trading firms simply "shrugged their shoulders" and walked away from the market. "They can't just take out 840 names" from their black-box models so they can play exclusively in non-financial stocks, where shorting is still allowed, he said.
Tal Cohen, a senior vice president at Instinet, agreed that the departure of many high-frequency trading firms from the market last week has reduced volumes. He said the SEC's ban shut down those firms' strategies by preventing them from shorting financial stocks.
"I'm not sure they're 50 to 60 percent of the market, but they've been a disproportionate share of the increase in volume" in recent years, he said. In 2003 and 2004 the market was executing three billion to four billion shares per day, Cohen said, whereas now it's in the seven-to-10-billion range. He added that the rise of trading by these firms is the result of reduced friction in the markets and regulation that has enabled the high-frequency firms to operate efficiently.
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