Disputing the Northwestern Brogaard Study

One of the overseas exchanges allows one of its managers to highlight the Northwestern University Study by Jonathan A. Brogaard http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1641387, as an empirical example of how beneficial HFT is in this article:


As the study has made its rounds, in its defense of HFT, I just wanted to point out our opinion on why the study is flawed, and it is the most common problem with any flawed study: GIGO (Garbage In Garbage Out). Data. Input.

Let’s talk about that data.

First I would like to point out the flaw that R.T. Leuchtkafer highlighted in his FT editorial here:


The study’s author weighted the 120 stocks by market cap to approximate the amount of profits HFT earns in the industry. More important,however,  is  extrapolating results by actual trading volume. Doing that, the estimate of profits jump to $6 billion, and not $3 billion.

Next I would like to talk about the source of the data, and what is included in it. It is provided by an Exchange (NASDAQ), and they pick 26 firms that they believe engage in HFT strategies. They exclude any firm that also gives DMA to customers, or does prop trading as part of more diverse strategies: ie they exclude all the large investment banks and brokers, who are among the largest HFT players in the world.

The study also is based on 120 stocks provided by NASDAQ (table 1 of the Brogaard Study), and does not include any ETF’s. I guess HFT firms do not make money in ETF’s. Or (as my next point will make) in stocks outside those 120 names.

Finally, as with another study that was pro-HFT recently,  it calls any HFT originating order that is a limit order Passive, and any HFT order that takes the other side Aggressive. I guess HFT does not exist in wide-spread mid and small cap stocks. If I place a bid in one of those stocks, and an automated HFT strategy places a limit order ahead of mine, because it is a limit order it is Passive, and not Aggressive, and predatory.

As this data is provided to the author of the study by an exchange, who in their for-profit model caters quite extensively to HFT firms, how can anyone place any credence in its conclusions ( HFT only makes $3 billion, HFT dampens volatiltity, and tightens spreads)?