High Frequency Trading is great for society!

/High Frequency Trading is great for society!

High Frequency Trading is great for society!

By | 2017-08-18T17:03:50+00:00 December 2nd, 2013|Uncategorized|9 Comments
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(Last Updated On: August 18, 2017)

Last week we transcribed some key sections from Jim Simons 2010 talk at MIT, “Mathematics, Common Sense, and Good Luck: My Life and Careers.”

We transcribed one question posed to Simons related to high frequency trading.

We often get questions about the merits of high frequency trading, and we thought Simons’ response was a pretty good answer to a question that many might find difficult to interpret.

Question: Do you consider high frequency trading to be socially useful, and if so, how much?

 I consider high frequency trading to be natural, and definitely socially useful.  What’s happened is that as the markets have become electronic, and computers have been applied to generating prices and accepting trades, and all the rest, is that the markets have grown tremendously more liquid. Spreads have come down, the bid/ask spreads have come down. The fellows who used to be the specialists on the floor, the specialists of old – they were supposed to be the market makers – they were full of baloney. And they would create very wide spreads, and at the first sign of trouble they would disappear. With the electronic trading has come the ability to trade fast, and that has brought spreads down and it has brought market impact down.

There are two things that happen when you buy a stock. One thing: you pay a little bit above the mid-price, just as if you sell it, you’ll sell it for a little bit below the mid-price. But the other thing that happens is, infinitesimally perhaps, you move the market. Well if you buy 100 shares you’re probably not going to move the market. But if you buy 100,000 shares you probably are going to move the market.  Well, how much are you going to move it? Well, if you’re the only buyer out there you’re probably going to move it a heck of a lot. But if there’s a lot of people active in that market, 100,000 shares might go very easily. So the more volume, the better. It’s volume that’s been created by these high frequency traders. So I think the research shows that the costs of trading – spreads and market impact – have come down a great deal, and it’s all due to high frequency trading.

So is it socially useful? Well if you think that highly liquid markets are socially useful, then I think so.

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About the Author:

Mr. Foulke is currently an owner/manager at Tradingfront, Inc., a white-label robo advisor platform. Previously he was a Managing Member of Alpha Architect, a quantitative asset manager. Prior to joining Alpha Architect, he was a Senior Vice President at Pardee Resources Company, a manager of natural resource assets, including investments in mineral rights, timber and renewables. He has also worked in investment banking and capital markets roles within the financial services industry, including at Houlihan Lokey, GE Capital, and Burnham Financial. He also founded two technology companies: E-lingo.com, an internet-based provider of automated translation services, and Stonelocator.com, an online wholesaler of stone and tile. Mr. Foulke received an M.B.A. from The Wharton School of the University of Pennsylvania, and an A.B. from Dartmouth College.
  • Thomas Musselman

    What about the type of high-frequency trading where the firm gets to see your order before your order is placed, effectively front-running you, but you don’t get to see their order?

  • That seems reasonable if they are trimming 5-10mils but enhancing liquidity. For long-term investors who trade infrequently, that might be an okay trade. Of course, the cost/benefit depends on the actual estimates of liquidity value-add and getting trade-raped.

  • On behalf of a reader…
    I think that asking whether “high-frequency trading” is beneficial is really too broad a question to be meaningful. Value-arbitrage strategies that focus on things like option market making, index arbitrage and ETF share creation, clearly improve market efficiency, and for the most part are simply more efficient implementations of traditional strategies.

    Latency-arbitrage strategies, however, are another matter. These strategies are based on the ability to act on information milliseconds before it is available to the general market. These strategies amplify existing liquidity, but they don’t create it. Front-running a large trade could double the volume of shares that change hands, but this additional liquidity is an illusion. Similarly, while reduced spreads are good in general, they are not beneficial if it’s the result of lower bids when you are trying to sell and higher asks when you are trying to buy.

    The worst of these strategies are those that engage in agressive quote stuffing to increase the time it takes for the rest of the market to see the real offers and thus increase their “edge.”

    Anyway, keep up the good work. I enjoy your blog and your monthly strategy updates tremendously.