The state of our financial markets has been a popular subject of debate lately. Unfortunately, amidst discussions on how to strengthen existing market structure, a lack of clarity around high frequency trading’s beneficial impact on today’s markets persists.
In his most recent article for Forbes, Tim Worstall provides a welcomed fact-based explanation of how high frequency traders save investors and traders money in the marketplace. According to Worstall, the question shouldn’t be whether high frequency traders make more money than other traders, but rather, “whether the existence of HFT leads to investors spending less money overall on trading in the markets.”
The answer? “Very much so, yes” writes Worstall. To support his position, he points out analysis by Professor Craig Pirrong on data in a paper commissioned by the CFTC investigating how HFTs impact liquidity in the marketplace:
“Specifically, Table 1 has data on spreads in from the electronic NYMEX crude oil market in 2011, and from the floor NYMEX crude oil market in 2006. The mean and median spreads in the electronic market: .01 percent. Given a roughly $100 price, this corresponds to one tick ($.01) in the crude oil market. The mean and median spreads in the floor market: .35 percent and .25 percent, respectively.
“Think about that for a minute. Conservatively, spreads were 25 times higher in the floor market. Even adjusting for the fact that prices in 2011 were almost double than in 2006, we’re talking a 12-fold difference in absolute (rather than percentage) spreads. That is just huge.
That spread is, if you like to think of it this way, what any investor or trader is paying for the privilege of being able to make a trade (and we might add to that broker fees, taxes and so on.) Those spreads coming down by a factor of 25 has obviously saved such traders vast sums of money over the years. So HFT does save investors money.”
End investors are not incurring losses as a result of HFT, and in fact, have much to gain from the lowered costs and increased access resulting from competition between these professional traders. Those in the HFT industry are making money gains as well (although this does come with risk.) Worstall then poses the question: if these two groups are benefiting who is “losing”? To find out, read Worstall’s full piece here.