Rebuttal: Some High Frequency Trading Is Good, Some Is Bad
But the market structure is definitely ugly
Traders Magazine Online News, March 18, 2010
I read Cameron Smith's well-written March 17 editorial in Traders Magazine online, and it echoes many other viewpoints on this topic that have been said in the past year, extolling the virtues of high-frequency trading (HFT). As a matter of fact, it echoes the same viewpoint that Mr. Smith made back in November 2009. We responded to his claims back then in our blog, http://blog.themistrading.com/?p=446, and we will do so again here.
The defenses of HFT are, and have always been:
- HFT adds liquidity and reduces spreads
- HFT aids in Price Discovery
- HFT Lowers Transaction Costs for All
- HFT is Market Making Evolved.
- There are no studies that show HFT to be harmful.
The professionals who make these arguments are all lawyers, consultants, executives at ATSs whose largest customers are HFT firms, and executives at exchanges whose largest customers are HFT firms. The defenders of HFT are defending a machine that earned multi-billion dollars in profits last year, and is expected to continue to grow. We offer our rebuttal as agency traders. We offer our rebuttal as the voice for many, many buyside traders and investment firms. We have been trading equities for clients on an agency basis for 20, and we have been doing this in a manner that always has embraced technology and change. In fact, we spent nearly a decade of our careers at Instinet Corporation. We have never been specialists, we have never been market makers making eighths and quarters and we have never been SOES bandits.
I make the above point, as any reader should question the motives of any strong viewpoint on an issue. We run a high-touch agency trading firm that is small, and small by design. That is our only stake. We are not against any one type of trading or investing, and have no moral yardstick that we use to size up market participants. We are agnostic to day traders, value investors, stat-arb players, momentum shops, GARP players, psychic traders, and HFT firms. We do take issue with a market structure that has evolved into one which favors specific participants over others. OK. On to our rebuttal ...
1) While HFT adds liquidity and reduces spreads in the top 100 stocks, the other 95 percent of U.S. equities have experienced wider spreads and more volatility. Why does every defender ignore that fact, and just lay down as gospel that HFT adds liquidity everywhere? We are happy that market players everywhere can trade Citigroup ($4), Fannie Mae ($1), Freddie Mac ($1), Bank of America ($17), Ford ($12), FAZ ($13), and countless other high volume large-cap names and ETFs, for penny spreads all day long. This is a good thing. If The Prince wants to sell out of his 200 million Citigroup shares, he can rest easy that the trade might take an hour or two to effect. But what about the small cap names? What about those names in which every posted display of liquidity results in 17 firms each penny jumping the original buyer or seller initially, and then each other subsequently, to create veritable volatile feeding frenzy events every time a player enters the picture? The predatory HFT at work in these lower market cap strata do not bless anyone with their "liquidity," and their activity certainly does not minimize volatility. Traders will tell you that.