Why there’s less high-frequency trading

October 15, 2012
Nathaniel Popper arrives today with something that looks like good news on the high-frequency trading front: there's less of it!

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Nathaniel Popper arrives today with something that looks like good news on the high-frequency trading front: there’s less of it!

Profits from high-speed trading in American stocks are on track to be, at most, $1.25 billion this year, down 35 percent from last year and 74 percent lower than the peak of about $4.9 billion in 2009, according to estimates from the brokerage firm Rosenblatt Securities…

The firms also are accounting for a declining percentage of a shrinking pool of stock trading, from 61 percent three years ago to 51 percent now, according to the Tabb Group, a data firm.

This is all true, and in fact it probably is good news, at the margin. But it’s not very good news, and it’s not as good news as it might look at first glance. Because while the number of trades is indeed going down, the number of orders is going through the roof. Here’s how I put it in my Radio 3 essay:

One reason that volumes are dropping is that the algobots are getting so sophisticated at sparring with each other that they’re not even trading with each other any more. They’re called high-frequency traders, but maybe that’s a misnomer: a better name might be high-frequency spambots. Because what they’re doing, most of the time, is putting buy or sell orders out there on the stock market, only to take those orders back a fraction of a second later, and replace them with new ones. The result is millions of orders, but almost no trades.

Call it the Stalemate of the Spambots: the HFT algos are all so sophisticated, now, that they just ping each other with order spam, rather than actually trading shares. Naturally, if you don’t trade shares, you can’t make money. But at the same time, anybody who does trade shares risks getting picked off by the very algorithms which are increasingly circling each other like prizefighters who never land a punch.

All of which is to say that just because HFT algobots aren’t trading as much any more, doesn’t mean that the waters are any safer for real-money accounts to re-enter. Indeed, the exact opposite is more likely: that the bots have poisoned the stock-trading waters so much that even the bots themselves fear to go in.

As a result, market regulators still have a huge amount of work to do, starting with a serious attempt to cut down on quote-spam. There’s no reason why regulators shouldn’t effectively ban the practice of putting in non-serious orders which disappear in the blink of an eye — although the risk, of course, is that if the algobots are banned from confusing each other with quote spam, then they’ll just revert to dominating trading instead. Which is why I still like the idea of a financial-transactions tax.

Popper says that “now that the high-speed firms are shrinking from the market, there are some indications that trading costs may again be rising.” This might be true, but it’s negligible: we’re talking here about a tiny uptick from 3.5 cents per share to 3.8 cents per share, after a long fall from a level of 7.6 cents in 2000. There’s no indication that this is either a trend or anything to be worried about.

In any case, let’s not assume that rising trading costs are always and necessarily a bad thing. Trading costs right now are incredibly low — low enough that they can, actually, rise a little bit without doing any visible harm. Fear of rising trading costs must not prevent us from continuing to prosecute the war on HFTs — especially if there are indications that we’re slowly beginning to win it.


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