Why High Frequency Trading is Not a Problem

Many people are concerned about the fact that some people can trade more frequently than they can due to having a large infrastructure of high speed computers and connections to various exchanges.  It all seems like regular people can get ripped off, and so some kind of governor is need via transaction taxes, or some limiter on the trade frequency.

This is all unnecessary. If you are concerned about being gamed by high frequency traders (aka HFT), there’s a pretty simple way to avoid this.  Simply trade using Volume Weighted Average Price (VWAP) orders. This order gives you the volume weighted average price for a period, usually a day, and on InteractiveBrokers it’s available pretty cheaply, say for half a cent a share.  Brokers have whittled this fee pretty much down to the exchange fees and spread, taking into account the fact that they trade these things ‘algorithmically’, so you actually benefit from HFT as they aren’t simply and stupidly crossing the market every half hour. Most HFT actually are simply common sense applied to generating a light touch by trying to emulate a market-maker (eg, posting buy orders at the bid) as opposed to something sinister.

Say you decide on Sunday, after doing all sorts of research over the weekend, that you want to buy IBM on Monday. If you are buying less than 1% of ADV, your effect on the price is positive to be sure, but spread out over the day, not quick enough or with a high enough certainty that one would want to front run you (ie, it’s not sufficiently greater than the spread to be worth buying in the morning and selling at close). Further, any information that might give a HFT a millisecond advantage within they day will be randomly because you can’t predict the sign of such innovations hours in advance, so HFT shenanigans are irrelevant to you, they aren’t biased in any direction.

Widows and orphans can execute VWAP orders now, and then benefit from any benefits in a perceived case where trading is simply done at a central auction once a day. Yet with this solution no one is constrained, no one has to monitor or regulate anyone. The solution exists currently and is available to everyone who want to avoid HFT.  Real investors shouldn’t be day trading, but making longer term decisions based on a longer term analysis of the trends, and in that case they can trade as if HFT didn’t exist without any new rules.

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About Eric Falkenstein 136 Articles

Eric Falkenstein is an economist who specializes in quantitative issues in finance: risk management, long/short equity investing, default modeling, etc.

Eric received his Ph.D. in Economics from Northwestern University , 1994 and his B.A. in Economics from Washington University in St. Louis, 1987

He is the author of the 2009 book Finding Alpha.

Visit: Eric Falkenstein's Website

2 Comments on Why High Frequency Trading is Not a Problem

  1. Do you have ANY proof to your claim that most HFT are simple common sense algo’s? Any data to back up your OUTRAGEOUS claim that VWAP is all the insurance you need against ad algo’s?

    It is writers such as yourself who are creating problems for those of us who understand the dynamics caused by nanosecond trading computers, expert networks, and a newly fragmented market where each exchange has its own RLP and complex fee structure along with special order types.

    First off, VWAP won’t do anything against a locked market or queue slide. Second, VWAP won’t help when the connected HFT firm (GETCo, VIRTU) are able to flip the fee from the taker side and make the maker pay it, all the while partially filling lots and offering sub-penny pricing.

    If you are ok with ignoring bad algo’s and not enforcing the rules we have paid the SEC to come up with and pass, then I expect you’ll turn your head over when your house is robbed.

    The problem is that the widows and orphans you talk about are not making their own trading decisions. Some MBA, CFA jibroni is sitting in his office making these trades and poo pooing HFT saying VWAP creates an environment where regulation isn’t needed. And what does he care, he gets his 1% and bets with your money, all the while ignoring HFT and marginalizing his fiduciary responsibility.

    Furthermore, you can know when HFT will be most prevalent. The fact that you state the opposite shows your lack of research into this area as bad algo’s and the negative effects introduced by them are visible on energy releases, major economic releases, European close, cash outcry close, and during the last hour trading when they are rebalancing. Please stop writing about HFT until you have researched it thoroughly.

    Again, please stop writing about HFT. Your limited exposure and understanding is skirting our effort to bring retail back to the market through the reestablishment of trust and a regulator who actually regulates and doesn’t cut corners by buying surveillance software from the very firms they seek monitor. Thanks for nothing big guy!

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