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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