Is High Frequency Trading a Blessing or a Curse?
Is high frequency trading a blessing or a curse? While you probably can guess our answer to the question, we thought it would be better answered by a new academic paper which is titled “A Blessing or a Curse? The Impact of High Frequency Trading on Institutional Investors” written by Lin Tong of the University of Iowa.
Tong takes a unique approach to analyzing the question by combining two distinct data sources: institutional trading data from Ancerno that represents 204 institutions and NASDAQ data on a sample of 120 stocks which identifies the data as being from high frequency trading or non-high frequency trading. Tong has some eye-opening results:
1- HFT activity is positively correlated with execution shortfall.
2- When HFT activity is more intense, institutional investors’ execution shortfall is higher.
3- The increasing effect of HFT activity on execution shortfall is stronger on smaller stocks.
4- When HF traders on the net are buying (selling), it is more costly for institutional investors to sell (buy).
5- Even though HFT activity increases institutional investors’ execution shortfall, it does not provide the benefit of reduced timing delay cost.
Wow, now those results certainly conflict with what we usually hear coming from the HFT proponents. Those data-driven based results seem to support the “anecdotal” claims that the SEC doesn’t seem to respect much.
How many times have we heard the HFT community preach about the benefits of HFT and how their added liquidity and shrinking of spreads has lowered trading costs for retail and institutional investors. At almost every industry conference that we have been at where we debated a member of the HFT community (or one of the surrogates), we usually here something like this quote which comes from an FT article written by Remco Lenterman:
“The empirical data show that it has never been cheaper and more efficient for institutions and retail investors to transact on these markets. Institutions today pay up to 90 per cent less commission through automated trading than they paid 15 years ago transacting over the phone.”
We’re not sure where Remco is getting his empirical data from but something tells us it’s not an unbiased source. When analyzing the effects of HFT, it’s important not to look at just one dimensional measures like spreads and commissions. Now that the SEC is about to release their MIDAS data, we hope and expect to see many more multi-dimensional reports like the one that we highlighted today.