Proponents of HFT heavily favor it because it creates liquidity in the market: more than ever before, at a certain time, you can expect to buy or sell a stock for it's current price. Because of the volume of trades going on at any given second due to HFT, the value of a stock is more accurate and will not change when an order is placed on it.
However, for brokers that actually know the system, they know that there is price changing "beneath the tape", so to speak. HFT computers buy place orders on certain stocks at certain prices, but then cancel these orders just as fast as a way to test the market. This is a way that the algorithms try to use their power to see the reaction of human investors to these small changes in price. There are also dozens of private trading platforms, called dark pools, that help hedge pools and other big-money players trade in relative secrecy.
Additionally, as talked about before in this blog, with HFT there is always the issue of volatility. We know that HFTs were not the cause of the Flash Crash, but they exaggerated its effects because many algorithms are programmed to stop trading in such catastrophic situations. Recent SEC regulation and implementation of "circuit breakers" in case of another crash may help, but we won't know until these come into play.
There have been other recent developments on Wall Street in relation to HFT. Dave Lauer, a former HFT algorithm creator, wrote an interesting piece for a segment on the National Public Radio show Marketplace. Titled "High-Frequency Trading: Bad For the Markets...and the Soul?", the piece explains how Lauer felt worse and worse after making so much money from HFT while the economy fell apart. "What was I doing to add value to the world?" he writes. He questioned the value of HFT and why it pulled so many people away from noble pursuits and into financial services so they could make fortunes from the market while others suffered. After two years in HFT, he quit his job.
More recently, the entire market for HFT is declining. Profits are way down, projected to be at the most $1.25 billion this year, which is down 35% from last year and 74% lower than the peak of $4.9 billion in 2009. As a comparison, banks like Wells Fargo and JPMorgan Chase each earned more last quarter than the entire HFT industry will earn this year. Due to these declining revenues, firms are also scaling back and even shutting down in some cases. The high cost of data technologies is one reason for the decline - to keep up with its competitors every HFT firm has to have the latest data to run their algorithms on in order to keep making profits. One executive summed it up perfectly: "People think it's easy money, but it's not."
Ultimately, how does high-frequency trading affect us, individuals who have an interest in investing in the market?
- First of all, you can easily buy or sell something in 16.5 seconds or less (this is the average execution time for an order, according to the NYSE)
- We have different motives: HFT algorithms are trying to win pennies whereas we are looking to make larger profits on fewer shares or stocks
- The SEC has "circuit breakers" now that halt trading if a certain stock suddenly drops 10% in less than five minutes
- We are similar to HFTs in the sense that we are both trying to profit from mispricing: buy low, sell high
- HFTs fill the gap between supply and demand: if there's no person that will buy something that you want to sell, a HFT will pick it up and sell it off later
- Unlike us, HFT firms can use computers to "sniff out" the market and spot trends, enabling them to jump ahead of institutional firms (for every trade that gets bought or sold, 90 offers are cancelled!)
[1] Linette Lopez, "What High Frequency Trading Looks Like To The Human Broker's Naked Eye", Business Insider, September 10, 2012, http://www.businessinsider.com/what-high-frequency-trading-looks-like-to-the-human-brokers-naked-eye-2012-9
[2] Dave Lauer, "High-Frequcney Trading: Bad For Markets...and the Soul?", Marketplace (NPR show), May 21, 2012, http://www.marketplace.org/topics/business/commentary/high-frequency-trading-bad-markets-and-soul
[3] Nathaniel Popper, "High-Speed Trading No Longer Hurtling Forward", New York Times, October 14, 2012, http://www.nytimes.com/2012/10/15/business/with-profits-dropping-high-speed-trading-cools-down.html?pagewanted=all
[4] Matt Levine, "Ask A Banker: High Frequency Trading", Planet Money (NPR show), November 7, 2012, http://www.npr.org/blogs/money/2012/11/07/164597638/ask-a-banker-whats-the-deal-with-high-frequency-trading
[5] Alexander Green, "Why You Shouldn't Fear High-Frequency Trading", Investment U, October 22, 2012, http://www.investmentu.com/2012/October/why-you-shouldn%E2%80%99t-fear-high-frequency-trading.html
[6] Dina ElBoghdady, "Is High-Frequency Trading a Threat to Stock Trading, Or a Boon?", Washington Post, October 25, 2012, http://www.washingtonpost.com/business/economy/is-high-frequency-trading-a-threat-to-stock-trading-or-a-boon/2012/10/25/9c39ff96-1865-11e2-a55c-39408fbe6a4b_story.html
It has been nice to see economic analysis of robotrading in your blog this past quarter. Before, I had only heard about the companies and algorithms in use, but I hadn't heard much about its actual economic impact.
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