“A key message: despite commonly held negative perceptions, the available evidence indicates that high frequency trading (HFT) and algorithmic trading (AT) may have several beneficial effects on markets. However, HFT/AT may cause instabilities in financial markets in specific circumstances”…UK Foresight Report 10/23/12
The above quote is from the final report of the UK Foresight project known as “The Future of Computer Trading in Financial Markets” which was released today. We think the Foresight Report missed the major issues regarding market structure. The fragmented market structure and conflicted interests of the for-profit exchange model are the key issues why HFT has grown so much. We think issues like market maker obligations, order types and the maker/taker (payment for order flow) pricing model should have been discussed further (the report punted on these issues).
The Foresight report repeatedly uses the standard pro-HFT arguments that the HFT lobby continues to use (shrink spreads, add liquidity). This is no surprise since the majority of the High Level Stakeholder Group that worked on the Foresight project are industry insiders.
Over the past few years, when HFT has increased dramatically, HFT has not significantly lowered spreads in the majority of stocks. We point to this chart produced by a HFT firm, RGM Advisors (see Figure 1) , which shows only a $0.015 spread savings since 2006. The majority of the spread savings has happened after decimalization in 2000 and was assisted by the rise of electronic trading (NOT high frequency trading).
The Foresight conclusions also seem to differ from an “End User Perspective” report that they produced. The end users were much more concerned about market structure issues than was portrayed in the Foresight conclusions. Foresight, however, seems to dismiss their concerns and almost even mock them:
“Claims of market manipulation using HFT techniques are reported by institutional investors such as pension funds and mutual funds in different countries. These claims are, in turn, widely relayed by the financial press”
The Foresight report claims that some of the negative perceptions surrounding HFT are not supported by the available evidence. Maybe they were looking in the wrong place. We would like to point them to the extensive bibliography of academic evidence compiled by our friend RT Leuchktafer.
The Foresight report declined to make any bold recommendations and instead decided to safely hide behind the standard HFT defense of “there is no evidence”. They seem to think that the “benefits” of HFT would be undone if regulators are not cautious in their approach. The Foresight team appears to be held hostage by the so called HFT liquidity. We’re sure that the HFT community will use the Foresight report as vindication. But we think their assumed vindication will ultimately prove to be premature.