HFT charts of the day, trading-cost edition

By Felix Salmon
August 14, 2012
Nathaniel Popper, today, runs this pair of charts, which basically tells us everything we need to know.

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14speed-articleInline.jpg The Nanex HFT chart I posted last week went viral, becoming by far my most popular post of the year; I even did a version of it for Buzzfeed. In the comments to that post, Kid Dynamite defended high-frequency trading by saying that spreads have tightened in substantially for everyone as a result of HFT. But neither of us really had the numbers — until now.

The NYT’s Nathaniel Popper, today, runs this pair of charts, which basically tells us everything we need to know. The main thing you need to notice is that the x-axis is the same on both charts, running from 2000 to the present day; my HFT chart from Nanex ran from 2007 to the beginning of 2012.

What’s clear from the top chart in the NYT (and from my Nanex chart) is that the explosion in HFT took place from 2007 onwards. And what’s clear from the bottom chart in the NYT is that benefits to small investors more or less stopped at that point.

First, let’s be clear about what these charts are showing. HFT is maybe a bit misnamed, since what we’re seeing here is two separate eras. From 2000 to 2006, trading got faster and cheaper. From 2007 to date, trading itself hasn’t actually risen much, or got faster. the huge spikes are in quotes, rather than trades, and it’s not uncommon for certain stocks to see more than a million quotes over the course of a single day, even when they are only traded a couple of dozen times.

You know the track cycling at the Olympics, where the beginning of the race is entirely tactical, and the trick is not to go fast but to actually position yourself behind the other person? HFT is a bit like that: the algorithms are constantly putting up quotes and then pulling them down again, in the knowledge that there’s very little chance they will be hit and traded on. The quotes aren’t genuine attempts to trade: instead, they’re an attempt to distract the rest of the market while the algo quietly trades elsewhere.

As such, the vast number of quotes in the market is not a genuine sign of liquidity, since there really isn’t money to back them all up. Instead, it’s just noise. But don’t take my word for it. Here’s Larry Tabb, the CEO of Tabb Group, and a man who knows vastly more about HFT than just about anybody else:

Given the events of the past six months, the SEC should think hard about the market structure it has created, and do its utmost to rein it in. While the SEC can’t stop computers from getting faster, there is no reason it can’t reduce price and venue fragmentation, which should slow the market down, reduce message traffic and lower technology burdens.

Until we can safely manage complex and massive message streams in microseconds, fragmentation is making one of the greatest financial markets of all time about as stable as a McLaren with its RPMs buried in the red.

HFT causes stock-market instability, and stock-market instability is a major systemic risk. No one’s benefitting from the fact that the entire market could blow up at any second. So why isn’t anybody putting a stop to it?

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Comments
6 comments so far

Felix,

as the head of electronic trading at a major sell-side shop asked me last week, rhetorically, when I made a similar comment to Tabb’s about fragmentation being the problem:

“how do you put the fragmentation genie back in the bottle?”

the reason markets got fragmented (different places to execute your order) is precisely because we got rid of the NYSE specialist system (which, as the NYT article notes “No one is saying that we go back to the floor specialists”) and replaced it with *competition.*

So it’s important for people to understand: the fragmentation of markets – the competition amongst different market centers to offer the best price and liquidity – is ITSELF what leads to an entire subset of HFT spewing all of these quotes to make sure that they 1) maintain their place in line and 2) maintain pricing order across the fragmented exchanges.

Is there further “benefit” to this for the rest of us? Maybe not – I see your point, but my counterpoint is: there’s also no reason to run around screaming that the sky is falling and that the robots are taking over, or that “the entire market could blow up at any second”.

Who cares – seriously – it really truly doesn’t have any affect on you when the algo-bots quote themselves to death. fact: You can’t even see it!

Aside, I am definitely guilty of generalizing that the alternative to our current structure is the NYSE Specialist monopoly which is terrible for investors and traders.

random thoughts: I think that most people advocating for a transaction tax have no idea what they are talking about, and that the consequences could be dire and are definitely bad for everyone. I also think that, as you mentioned, there is little/no benefit (and also, perhaps, little/no harm!) to continuing to try to speed things up on a scale that retail investors cannot even see (as I already noted), and that a limit on speed/quote volume probably wouldn’t hurt bid/ask spreads too much (ie: no more than 5 quoting/trading time periods per second – just throwing 5 out there as a random number – others have suggested various numbers from 1 to 100)

Posted by KidDynamite | Report as abusive

Why not put minimum liveness times on quotes and positions? Require that any quote entered into the system must remain live for 1 second and any position actually purchased must be held for 1 second.

Posted by Fowles | Report as abusive

Felix,

The chart embedding does not seem to work [ though I was able to see it on the NYT website ].

I am going to make a number of points here:

1. The NYT chart does not support the Nanex chart in any meaningful way: Nanex seemed to imply that quote volumes have gone up 15? 20? times since 2007, while the growth in the NYT chart is much smaller. The NYT chart also measures quote traffic in the single busiest minute; it is a reasonable assumption that the average, or the 90th percentile, would have increased much less than the numbers for the busiest minute.

2. There are two very good reasons for quote volumes to be up since 2007, beyond the (further) proliferation of HFT:

- there were simply more news driven moves in that period than in any other recent period, and news driven market activity happens in the minute or two after news breaks;

- the continuing growth of market centers is leading to greater numbers of both liquidity providing and liquidity taking orders. For example, if all you had was the NYSE, you would send your order for 1000 shares only to NYSE; now, you have to split it into 100-200 share chunks and send to NYSE, ARCA, NASDAQ, BATS, EDGA, EDGX, …. The trading volume does not change, but the quote volume goes up a lot. Many HFTs run strategies designed to exploit this fragmentation, and many couldn’t care less if the fragmentation went away.

I can say with a fair degree of confidence that HFT in the US equity markets pretty much reached its peak in 2008. No significant new participants have sprung up since then, and no existing participants have greatly expanded their activities.

3. You also allege that HFTs use quotes to mask their true activities. This is, to put it bluntly, absurd. Although people call them “quotes”, the stockm arkets are not quote-driven but order-driven systems. And each order is a commitment to trade at that price in that quantity. These orders are churned a lot, but I will submit that most of this churn happens because it can: an HFT system trades on a signal, it recalculates that signal as often and as fast as it can, and it submits or cancels orders based on what the signal says. A lot of this submission or cancellation happens, in all honesty, because there are no constraints on how much of it you can do, or how fast. Once you place reasonable constraints, in the form of minimum trade-to-order ratios, or minimum resting times, the churn will go down. That doesn’t mean HFTs are engaging in any nefarious practices now which they will not engage in then.

4. You echo the NYT in saying that the cost benefits have been through the narrowing of spreads, and that this has stopped around 2008. While I broadly agree with that assertion, I will also say that another big cost reduction has been through a decrease in brokerage fees, which has come about mostly through automation and the adoption of algos/HFT technologies.

PS: if it is not clear, I work in the area. I’m happy to discuss any of this at greater length if you wish.

Posted by m_m | Report as abusive

“And what’s clear from the bottom chart in the NYT is that benefits to small investors more or less stopped at that point (2007). (FS)

What benefits to anyone but themselves? HFTs extract money from the ultimate exchange between a genuine buyer and seller. How is that even conceptually good for either of the muppets?

Posted by MrRFox | Report as abusive

MrRFox: “What benefits to anyone but themselves? HFTs extract money from the ultimate exchange between a genuine buyer and seller. How is that even conceptually good for either of the muppets?”

Quality markets have always had, and will always have market makers. These market makers provide a service to the market and are compensated for the risk that they take. In years past, the specialists of the NYSE served as market makers. Today, HFTs are market makers. To say that HFTs extract money from the ultimate exchange between buyer and seller is true, but demonstrates a lack of understanding as to how markets operate.

Posted by Jon05 | Report as abusive

It hardly worth considering the facile size of the spread without considering how much one might transact at that price as well as the cost of transacting orders of increasing size. One needs to ruminate upon such a chart in (at least!!) three dimensions – the third being size. For what is the utility of a tighter inside spread if HFT creates a feedback loop from initial transaction/quote-change information that elevates the ultimate cost of completing one’s transaction? I’m not saying it definitively does increase the cost, and comparatively specialists of old and NASDAQ mmkers were no angels or altruists, but it serves little purpose outside positive PR for HFT to make less-than-sensical definitive and categorical statements about HFTs relative and absolute virtue without a little more substantiation.

Posted by nihoncassandra | Report as abusive
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