Fees on trading would not meaningfully discourage high frequency trading and would just be passed on to buyers and sellers of stock in the form of larger bid/ask spreads.
The HFT shops put millions of dollars into research to attempt to ascertain correct prices (e.g. ETF pricing, derivatives pricing, etc). If they are disincentivized from trading in the equities markets, they will no longer be a conduit of relevant pricing information from other global markets into the equities markets. That means investors (big Wall Street firms catered to by IEX) and retail (you and me in our individual accounts) are more likely to be trading mis-priced markets.
You seem to take it at face value that trading at accurate prices is an unalloyed good. But for the extremely overwhelming majority of retail investors — whose only sane strategy is buy and hold — buying at a few tenths of a percentage points closer to the most-accurate possible price is worth nearly nothing (and has negative worth half of the time, practically by definition).
On the other hand, Wall Street has been raking in tens if not hundreds of billions in profits from this service. What value we get from more accurate pricing may very easily be offset by these costs a hundredfold.
I think you are also underestimating the costs to retail investors to not getting accurate pricing. Shaving a few tents of a point off of every trade will have a huge effect on the lifetime earnings of an individuals.
They made 147M in the first quarter of this year. 197M in the first quarter of last year. They might only make 100M/year after costs, but that doesn't represent the 600-900M they take from the market.
HFT is rounding error.
You can't estimate it that way as they don't win or profit on all their trades. At it's height HFT was estimated to responsible 15-25% of daily volume by best guesses (it's some what obfuscated.) I'd be surprised if it was less than 5% today. Not just Virtu of course - all players big and small.
When people talk about making $0.0001 per share that's their ex-ante expectation. It accounts for the fact that you're not going to make money on every trade.
Furthermore, in exchange for "taking" that money from the market, they enhance liquidity, which is directly helpful for price discovery and facilitating trading among both retail and institutional investors.
People are continually moving the goalposts in this thread and others like it. If you're going to talk about Wall Street and fraud, high frequency trading is not the place to start. All of the legitimate arguments against high frequency trading have nothing to do with fraud, they have to do with the dangers of runaway algorithmic trading that coalesces into the same market movements.
But we can't reason about that issue while half the people talking about HFT (almost none of whom actually have experience with trading whatsoever) still think it's front running, or believe it constitutes some sort of fraudulent con over "the little guy."
This is an inaccurate framing of how high frequency trading propagates liquidity in an otherwise illiquid (or strictly less liquid) market. The claim is not that liquidity is contributed on a strictly trade by trade basis, but rather than the low-latency activity has meta-reactive effects owing to enhanced price discovery that increase overall participation by drawing in other traders at different time resolutions. For example, where there may a stagnant order book on one equity (and consequently, few human traders able to fulfill orders without significant pricing penalties), the same order book may draw in competing market makers. They attempt to predict the next price movement - some win and some lose on the immediate sequence of trades, but the consequent activity narrows the bid/ask spread by heightening local participation in the order book and improving the pricing confidence. This has practical ramifications for "human" time resolutions, because the human traders now have a better opportunity to fulfill orders without overpaying. This in turn reduces overcautious traders from participating, and so on and so forth.
For what it's worth, your line of argument has been rehashed for years now on Hacker News, going back to when Chris Stucchio wrote his HFT apologia. Instead of lazily linking to that thread, I'll do one better by walking through research on the subject. Fortunately there is a handy paper that explicitly examines the question, "how does the interaction of these traders in the millisecond environment impact the quality of markets that human investors can observe?"[1] The data is constructed using NASDAQ TotalView with equities in the S&P500 in periods of varying volatility. Both reactive and periodic trading algorithms are reviewed.
Here are a few critical passages:
By tracking submissions, cancellations, and executions that can be associated with each other, we create a measure of low-latency activity. We use a simultaneous equation framework to examine how the intensity of low latency activity affects market quality measures. We find that an increase in low-latency activity lowers short-term volatility, reduces quoted spreads and the total price impact of trades, and increases depth in the limit order book.
IV.B. Results Panel A of Table 4 presents the estimated coefficients of the pooled system side-by-side for the 2007 and 2008 sample periods. First we note that the two instruments have the 25 expected signs and are highly significant. Specifically, the coefficient a2 indicates that when liquidity off NASDAQ is higher, our NASDAQ market quality measures show higher liquidity and lower volatility. Similarly, the coefficient b2 is positive in all specifications, indicating that higher low-latency activity in a specific stock in an interval is associated with higher low-latency activity in other stocks on the NASDAQ system. Second, the estimated b1 coefficients tell us that low-latency activity is attracted to more liquid and less volatile stocks.
The fact that low-latency trading decreases short-term volatility and contributes to depth in the 2008 sample period where the market is relentlessly going down and there is heightened uncertainty in the economic environment is particularly noteworthy. It seems to suggest that PA activity creates a positive externality in the market at the time that the market needs it the most. Panel B of Table 4 presents roughly similar results from the estimation of the system with SpreadNotNasi as the instrument for market liquidity.
It is possible, however, that the impact of low-latency trading on market quality would differ for stocks that are somehow fundamentally dissimilar, like small versus large market capitalization stocks. Table 5 presents system estimates in subsamples consisting of four quartiles ranked by the average market capitalization over the sample period.22 There is not much pattern across the quartiles in the manner low-latency activity affects short-term volatility in the 2007 sample period. The picture in the 2008 sample is different: It appears that during more stressful times, low-latency activity helps reduce volatility in smaller stocks more than it does in larger stocks.
Lastly, Table 6 shows summary statistics for the stock-by-stock estimations. The results suggest similar conclusions concerning the effect of low-latency trading on market quality. In particular, an increase in low-latency activity decreases short-term volatility, decreases quoted spreads, and increases displayed depth in the limit order book. This is true both in the 2007 and 2008 sample periods.
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1. http://people.stern.nyu.edu/jhasbrou/Research/Working%20Pape...
A few tenths of a percent is on the order of less than $100/year assuming that a retail investor invests the maximum amount allowed inside a 401k each year (ignoring for a second that typical 401k plans do not permit investing directly in individual stocks and also ignoring catch up contributions for older folks). It's just not a significant amount of money at the level of an individual retail investor.
The average retail investor should not be making enough trades for this to matter.
Bringing down the price of trades like this only makes it cheaper for the suckers — day traders — to think they're playing the game. It is of marginal utility for the average retail investor.
Yes, there's some nice compounding in between, assuming that you buy and hold with no further trades. But, there's a wide gulf between "day trading" and active stock-picking. Assuming that your average hold time is 5 years per stock, you're still going to rack up a lot of commission costs at $35 per trade.
Am I missing something here?
Yes. By paying relatively small amounts to high frequency market makers in return for enhanced liquidity and price discovery, you won't be overpaying by 1% (or more). I also challenge the idea that it would just "balance" itself out, in the absence of evidence supporting that thesis. In actuality you'd likely just amplify the costs you already have and either fill fewer trades or have higher costs for doing so.
Choosing to lose $1 due to low liquidity instead of a few cents due to market makers is both petty and nonsensical. There are legitimate arguments against HFT, but they don't begin by trying to reinvent economics such as to de-emphasize optimal price discovery.
That's not really that much in the scheme of things, but it's only one company, and I doubt the other investors would be willing to spend similar on insurance against volatility.
It really isn't though. It's been maligned as part of a smear campaign by the actual rent-seekers, Wall Street proper, as other commenters have noted.
What? No it wouldn't. You are disproportionately rewarding makers in this scenario. You would find plenty of listed orders, which somewhat looks like liquidity, but it would not be a liquid market. The end result would be a market that is actually less liquid because no one wants to fulfill orders. It would be utterly lopsided.
How many times do you trade a year? Actually perform trades? Even including mutual funds, I think it's < 100 yr.
It's becoming truly kafkaesque how often this claim comes up on Hacker News.
However the term has expanded a lot over the years to mean a lot of different things to a lot of different people. So what does it mean to you?
Anyway, I agree with you. I don’t see a significant downside to using a small transaction tax or one of the other suggestions. The real hard question is about the benefit or harm of HFT itself.
I haven’t heard a decisive argument yet, but I would say that the “liquidity defence” of HFT is in unconvincing to me. I don’t see how liquidity can add value past a certain point.
As I said though, I agree with you that there's an onus on those proposing a HFT tax to convict it convincingly. I don't think this has happened yet. The argument can't be "weird and scary." I don't see the liquidity defense. How can liquidity beyond a certain point be meaningfully more useful, but that's not a conviction. In my mind, it rests on how HFT impacts economic fragility, and increases the likelihood or impact of busts.
We're talking about something like a 0.02% of equity tax on HFT specifically or lower if it's going to be everyone. That does not impede the ability to price in real information.
An artificial restriction on trading is not unlike natural ones. Did we have liquidity issues when trading in and out multiple times within tenths of seconds was impossible? I don't think the cost is high. The risk is ..unproven.
Yes. Spreads were a dime (or more). Now they're a penny.
Said proposed tax is nothing more than people who can't compete trying to punish those who can because they don't understand why they're losing.
HFT has improved the market for everyone involved, spreads are lower, liquidity is higher, everyone pays far less for trades than ever before. There's no reason at all to regulate it that isn't simply fear based.
Proposing a tax on trades is punishing those presumed guilty without a lick of actual evidence they are. HFT don't need to prove they're good, they're just traders making trades in the market like anyone else, that they do it faster than a manual trader doesn't make them bad. To try and regulate them should require an actual case be made against them and all such cases I've seen so far are completely irrational emotional arguments by people who just want to point a finger at someone to explain why they're no longer able to compete.
This seems pretty convincing to me. The argument is that, based on the amount that firms are willing to spend on fiberoptic cables to perform hft, they put an extremely high value on hft. On the other hand, reasonable back-of-the-envelope calculations show that the social benefit of making the trade slightly faster are much less than the private cost. This indicates that almost all of the private benefit from hft comes from value accruing to the hft firm at the expense of other hft firms. We therefore expect to see overinvestment in hft.
What about this do you find objectionable?
Here is Vanguard's CEO on the topic:
http://www.cnbc.com/2014/04/25/vanguard-chief-defends-high-f...
That blog post also makes a mistake of claiming that the advantage of these sorts of fiber optic cables is to let people complete their trades faster. That is not the case. They enable people to execute their trades at better prices. The way he is looking at this issue is almost silly.
Do we really measure the social good of Google by how much capital they put into their fancy server clock syncing (the exact name of the project escapes me)?
How did we get to a point where "reasonable back of the envelope calculations" are what people seriously consider when trying to develop economic policy for the biggest economy in the world?
Why do you want to reduce high frequency trading?
This article has a lot of the reasons. I think loss of confidence in Market Integrity is the most important one.
I'll contest the "confidence in the market" hypothesis, however. As more investors move to index funds, I don't believe "confidence" as defined would have any significant impact by increasing or decreasing, because fewer participants overall will be actively engaged.
I do think if confidence in the market gets low enough it is possible that people will stop investing all together or invest less than they would have. But that is me sidestepping the issue a bit.
High frequency trading only works inasmuch as transaction costs are low, at least that’s my understanding.
If I understand your thesis correctly, you want to decrease liquidity in order to reduce the speed at which high frequency trading can be executed?
I'm not following your point about transaction costs - or do you mean that you'd limit HFT by reducing liquidity, which in turn would reduce their volume, reducing their trade discounts?
The “thesis” is that by putting a small tax on transactions, you will decrease the profitability of trading strategies that involve trading securities many times therefore discouraging them.
Liquidity is a trickier concept. I’m not sure if it has a consistent measurement definition. If you define liquidity as turnover or something close, then lowering trading frequency lowers liquidity by definition. How that affects liquidity in the practical sense for a “regular” investor is an uncertainty. It’s hard for me to imagine that a trader that holds stock for an average of 1 year will have more trouble getting in or out of Google stock, but maybe I’m wrong.