Debunking the HFT myth – 13 December 2010
First Published Monday, 13th December 2010 03:04 pm from Fidessa : Steve Grob
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I came across an interesting paper the other day
The HFT community
has come in for quite a bit of stick recently and so it was
refreshing to see an intelligent and well argued explanation of
its role in today's financial markets.
target="_blank">GETCO makes is that high frequency
trading is not a trading strategy in its own right. Instead,
trading with high frequency (or with high speed and volume) can
reflect a number of different trading strategies. Where it is
supporting electronic market making then speed is crucial as the
market maker needs to minimise his 'exposure
time', i.e. that period when he cannot modify a quote
in response to changing market conditions. At least for market
making, then, high speed is actually a way of reducing risk
rather than increasing it.
The paper goes on
to say that electronic liquidity providers like title="GETCO" href="http://www.getcollc.com/"
target="_blank">GETCO actually increase overall
liquidity and reduce volatility by buying when others want to
sell, and vice versa. The real debate, though, stems from exactly
how obliged the 'modern day market maker' is
to maintain these two-sided quotes especially when markets are
target="_blank">GETCO rightly argues, however, that
its role as designated market maker (DMM) or Lead Market Maker
(LMM) on many venues and stocks means that it is subject to very
specific obligations in this regard. And so, ironically, the
target="_blank">GETCO can access markets the safer
they would appear to be.
The other issue is
how such firms are rewarded for their provision of this liquidity
to markets. In the old days market makers earned the bid/ask
spread between the quotes that they provided but this has changed
since the introduction of MiFID. First, the maker taker pricing
models operated by many alternative venues provide extra reward
(in terms of rebates) to those firms that lodge passive liquidity
on their platforms. Second, the increased competition between the
venues has led to an overall reduction in tick sizes which
favours electronic liquidity providers over the more traditional
I guess the problem comes with
the high frequency players that simply siphon liquidity between
venues in order to take advantage of maker taker rebates without
any real obligation to consistently make two-sided
target="_blank">the paper and have your own say in
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