A new Bank of Canada study on HFT makes no definitive call on whether the practice is good or bad for markets.Getty Images/iStockphoto
The Bank of Canada has released a research paper on high-frequency trading that, unfortunately for those looking for a silver bullet that finally answers whether HFT is good or bad, provides ammunition for both sides.
The study takes advantage of a very helpful four-year data set from the Alpha alternative trading system, complete with trades and orders time-stamped to the millisecond and markers that identify individual traders. As data sets for HFT studies go, this is good stuff, and the researchers are able to see when individual traders begin to be active on any one stock. They can then compare how those stocks behaved before and after, as well as see stocks that have no HFT to provide control groups.
The study is also pretty readable, as such things go. It's not Michael Lewis's Flash Boys, but it's not overrun with formulas and jargon.
As good as it is, the study is not going to settle the HFT issue. The results of the study back what both critics and proponents of HFT argue. The study finds that in the first stage of HFT activity on a stock, the HFT strategies are generally "passive" strategies that are consistent with market-making.
The bid-ask spreads on stock shrink, which is a benefit to anyone buying and selling stocks as the difference between the bid and ask prices is generally what accrues to intermediaries. That's one big argument of HFT backers.
Then stage two happens, and "aggressive" HFT firms enter, behaving in a way that "is consistent with high-speed price forecasting," and "incumbents experience a loss in their ability to trade in the direction of future price movements."
"More firms are trading to [gather] information into prices, deteriorating the predictability of prices," the authors write.
In other words, it gets harder for those who had been in the market to read the new market, and it's tougher to trade. That's a tick in the column of the HFT opponents, who say HFT's constant use of orders and cancellations to try to figure out the market's direction creates noise that makes it difficult for other investors.
In both stage one and stage two, it's the first HFT or two trading a stock that has the largest effect. Later entrants make a difference that quickly becomes statistically insignificant.
The study also finds that the more HFT firms that pile in to trade any one stock, the less money they make as they begin to fight over what appears to be a finite slice of market share.
So the result is somewhat ambiguous. Some HFT helps, some HFT hurts. It rings true, but it's unlikely to satisfy those who have staked out their positions on the edges of the debate.