09
Jul, 2009
09
Jul, 2009
Why Institutional Investors Should Be Concerned About HFT
Why Institutional Investors Should Be Concerned About HFT
By Sal L. Arnuk and Joseph Saluzzi
A Themis Trading LLC Mini White Paper
It is now generally understood that high frequency traders (HFTs) are dominating the equity market, generating as much as 70% of the volume.
HFTs are computerized trading programs that make money two ways, in general. They offer bids in such a way so as to make tiny amounts of money from per share liquidity rebates provided by the exchanges. Or they make tiny per share long or short profits. While this might sound like small change, HFTs collectively execute billions of shares a day, making it an extremely profitable business.
Why should institutional or retail investors care? After all, aren’t HFTs adding liquidity? That’s what they and the exchanges, who court their business, say.
There’s a lot to worry about.
In the old days, when NYSE specialists or NASDAQ market makers added liquidity, they were required to maintain a fair and orderly market, and to post a quote that was part of the National Best Bid and Offer a minimum percentage of time. HFTs have no such requirements. They have no minimum shares to provide nor do they have a minimum quote time. And they could turn off their liquidity at any time. When an HFT computer spots a real order, the HFT is not likely to go against it and take the other side. The institution is then faced with a very tough stock to trade.
This can cause other investors to buy at a higher price, or sell at a lower price, than they would otherwise. A spike in HFT volume can cause an institutional algorithm order based on a percentage of volume to be too aggressive. A spike can attract momentum investors, further exaggerating price moves. Seeing such a spike, options traders can start to build positions, which, in turn, can attract risk arbitrage traders who believe there’s potential news that could affect the stock.
Because most HFT servers are co-located at exchanges, they can beat out institutional or retail orders, causing them to pay more or sell for less than they should have for a stock.
Then there are the “what if” problems that could be created by HFTs.
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Volumes could implode and stocks that appeared highly liquid could become extremely difficult to trade with wide spreads and no depth in the quote.
Many HFTs are hedge funds that enter their orders into the market through a “sponsored access” arrangement with a broker. Many of these arrangements do not have any pre-trade risk controls since these clients demand the fastest speed. Due to the fully electronic nature of the equity markets today, one keypunch error could wreak havoc. Nothing would be able to stop a market destroying order once the button was pressed.
Gives new meaning to the term “mutually assured destruction?”
Joseph Saluzzi (jsaluzzi@ThemisTrading.com) and Sal L. Arnuk (sarnuk@ThemisTrading.com) are co-heads of the equity trading desk at Themis Trading LLC, an independent, no conflict agency brokerage firm specializing in trading listed and OTC equities for institutions. Prior to Themis, Mr. Arnuk worked for more than 10 years at Instinet Corporation, where he headed the team responsible for equity sales and trading for major institutional money managers. Mr. Saluzzi worked for more than nine years at Instinet, where he headed the team responsible for equity sales and trading for major hedge fund accounts. For more information, call 973-665-9600.
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For many years I have been using a swing trading system that includes heavy reliance on price-volume correlation.
http://www.moneyfromthemarket.blogspot.com
While I see the dramatic increase in overall volume in the markets, I do not see it as skewing any signals I use.
There is nothing new about the sort of pump-and-dump schemes you seem to be describing. I agree the economy is in trouble and the markets are equally so, but trading systems need to adjust to the times and flex with new market quirks.
I believe that stocks in the market are generally way over-priced. with up to 50% of the price of a stock just emotional value based on supply and demand having little to do with the actual value of a company — it’s just hype, or to be more polite, Wall St.’s recognition of a company’s apparent value. If that is the case, then it’s all manipulation anyway. Understanding that is what drove me to learn to trade instead of “investing”.
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