Why High Frequency Trading is here to stay

The video above has attracted a lot of attention. It displays the trades in Johnson & Johnson shares that occurred in just half a second of trading on 2 May. Each box represents one exchange and at the bottom you can see the National Best Bid and Offer fluctuate.

It's easy to be panicked by what's going on, and many argue that if these lightning fast system face difficulties then rivals will be able to reap profits through arbitrage opportunities. But Remco Lenterman, chairman of FIA EPTA, argues that the benefits of High Frequency Trading (HFT) are convincing:

Let’s look at some of that evidence. HFT has substantially reduced frictional costs in the markets and is therefore of benefit to end-users, including pensioners. As Vanguard has stated, transaction costs in US equities have decreased by about 60 per cent in the last 15 years. These lower transactions costs will enable mutual fund investors to expect an investment balance around 30 per cent higher than they would have otherwise.

Equally misguided are assertions that HFT causes volatility. Much academic evidence shows that it either does not affect volatility, or even reduces it. Volatility is more likely to be caused by macroeconomic and financial developments. And rather than leaving the market at times of high volatility, as is claimed, the evidence suggests that HFT firms do the opposite. Our organisation’s figures on the amount of trading by our members shows that our market shares peak in periods of volatility.

Then there is the charge that high-frequency traders provide “fake” liquidity, withdrawing quotes before they can be acted upon. This is impossible. Automated and regulated exchanges simply do not enable fake quotes. These markets are not a cat and mouse game, where the mouse gets back in its hole as soon as he sees the cat. In the exchange traded markets the only way the mouse knows that there is a cat is when he’s already been eaten. In addition, in a large amount of the trades executed on exchanges, our members are involved on at least one side of the trade. The liquidity that we provide is very real and very essential.

Our critics choose to overlook the value we add to the real economy. We lower transaction costs and increase liquidity. As such, we urge policymakers to weigh up the costs of regulatory reforms. No one benefits if badly designed regulations disrupt liquidity and drive up costs for traders and investors.

(Full article)