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The search for the term "high frequency trading" on the Internet yields over 1.25 million results with the vast majority of these results having been posted since June. That's not to say, there was no mentioning of high frequency trading in the prior months, and even years. However, now most of those articles are hopelessly lost as a result of the current media frenzy covering HFT in the recent months. What has caused the doors of the high frequency trading discussion to fly off the hinges? We'll get to that, but first, let's define what HFT for the purpose of this discussion.
The market footprint of this type of HFT trading is estimated to have reached 73% of equity volume traded in the U.S. while the number of trading firms engaged in it is about 2% of the total number of equity trading firms. I don't know where these numbers came from but they seem to be echoed throughout many articles. While it is easy to agree that the number of high frequency trading outlets is a smaller percentage of the total of number of investment firms, the exact figure is difficult to prove because of the secretive nature of such firms' operation. The percentage of total market participation reaching almost75% suggests that at least 50% percent of the market volume is the result of HFT firms trading against other HFT firms. Assuming of course that it still holds true there is one buyer and one seller behind every share traded on the market. This percentage seems to be a bit exaggerated to say the least.
Since HFT firms have existed for more than five years, though in smaller numbers, why have so many people voiced their anger over high frequency trading only recently? Personally, I believe this can be attributed to the state of our economy. Our economic troubles have expedited rapid changes to the investment industry, including advancement in technology, which has gradually diminished human value in certain areas. In addition, I believe human jealousy is at play as well, in that people are jealous of the success many high frequency traders are experiencing. During what was perceived as a "good economy" several years ago when many financial firms were enjoying steady returns on their investment strategies. Who would get irritated with the fact that there were some high-tech oriented firms that also turned some profits while keeping their risks to the minimum? Who cared? Everybody was making money.
Well now things have changed, and they have changed rapidly. Stocks have lost their value. Investors have pulled out their money from the stock markets after having sustained drastic loses. Now everyone is suffering. But wait... not everyone. When some firms are making a killing while the rest of us are suffering, people start speculating that they must be doing something illegal or unethical. The process of demonizing the successful ones has started.
High frequency trading has even been likened to a Ponzi scheme. HFT has caused a furor because of its low risk profile and it angers some traders and even Senators as purely speculative market exploitation. What should we then call the "traditional" style of investing, in say General Motors that drove the price of its stock from just under $20 in 2006 to just over $40 in 2008 while General Motors had a net loss of $73 billion over the same period of time? Probably something along the lines of fundamental research-based long-term investment for the benefit of the investors.
The general sentiment of the non "HFT" financial community is that HFT is using powerful computers, fast networks and sophisticated quants to achieve an unfair advantage over the rest of the market participants. This is to the same degree or reasoning as a car has an unfair advantage over the horse in logistical competition, and a computer has an unfair advantage over the telephone as far as trading goes.
However, the argument that high frequency algorithms always contribute to the markets efficiency and price improvement are questionable. HFT can also sway markets or enhance market trends just like conventional investment and trading strategies do. And the price improvement benefits resulting from high frequency trading are one sided. I'd rather define high frequency trading as the intermediary agent between sellers and buyers that improves the price for one participant while causing a contrary affect on the other. So, in a sense, HFT is clipping the price spread difference and capturing ECNs' rebates.
As in all other kinds of trading you can discover their positive and negative sides, but you cannot only have one. Some of the bitter ideas circulating throughout the community, such as regulating the speed of trading in the markets to a human clickable interaction speed allowing all traders time to review quotes visually and respond to them manually sounds to me like an attempt to align the industry to the slowest and the least technically advanced participant. As long as every participant has an equal opportunity to advance oneself, it is a fair game.
