Frankly, everyone is sick and tired of watching high frequency trading get dragged through the mud by the press, politicians, and the public. Just like the short sellers were vilified wrongly in the 1930′s for being the puppet master culprits behind the Great Depression, today high frequency traders are mistakenly believed to be the evil force causing our current economic woes. Nothing could be further from the truth. With this in mind, here is a bucket list of the top 10 reasons HFTs are not evil.
Reason #1: HFT Lowers Trading Costs For Everyone
Traders and investors are all very interested in obtaining the lowest transaction costs possible. High frequency trading lowers transactions costs for all in a variety of ways. By tightening bids/ask spreads, adding liquidity to the market, creating positive market innovations, adding liquidity to markets and making markets more efficient, investors of all sizes experience reduced costs of trading.
Reason #2: HFT Tightens Bid/Ask Spreads
This is one way HFT lowers transaction costs for everyone involved in the market. By tightening the spread between the bid and the ask, traders are able to buy and sell with less inherent cost within the transaction. Just look at the last 10 years in the stock market. Costs have plummeted while spreads are the tightest ever, creating an even playing field.
Reason #3 HFT Adds Liquidity To Markets
70% of the volume on the New York Stock Exchange is from high frequency trading. This is a staggering number. Can you imagine how sluggish the markets would become if 70% of the volume was slashed due to eliminating HFT?
The added liquidity raises concerns of HFT traders pulling out of the market en masse during times of crisis. This stopping of trading could trigger liquidity depletion—potentially causing markets to grind to a halt. While this is theoretically possible, the correct solution is not to ban HFTs, but for proper and fair regulations. Ideas have included placing market maker-type rules on HFT shops forcing them to continue trading regardless of conditions. Other thoughts have been to create a financial instrument that will allow HFT shops to hedge their exposure despite deteriorating market conditions while remaining in the market providing liquidity. One of these proposed instruments has been designed by Paul Tudor Jones’ group and is named Volume Synchronized Probability of Informed Trading, or VPIN. The market will find a solution to the possibility of HFTs causing liquidity events. It is quite obvious that the liquidity provided by HFTs far exceeds the potential issues raised.
Reason #4 HFT Helps Price Discovery
Price discovery is how an instrument gets priced at a certain level. Due to the transaction speed inherent within high frequency trading, price is thereby created faster, which spells better and more opportunities for those reliant on price.
Continued in PART 2 (coming soon)
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