New Revealing paper on High Frequency Trading

Scientific papers about politically controversial topics that involve billions of dollars of money flowing around in firms that can potentially hire the author later, need to be taken with a grain of salt. A large grain of salt. Sad but true. You can't trust science papers about politically controversial, money-impregnated topics the way you can almost sorta sometimes trust science papers about completely noncontroversial topics.<p>I have no particular reason to distrust the author or the paper. Only general reasons to distrust the topic.

Based on my experience building HFT systems and communicating with others doing HFT, the results of this study sound about right. HFT traders are essentially just market makers, meaning that they generally place orders on both sides of the market in an attempt to profit from short-term mean reversion.

The author makes use of a dataset of trades from major exchanges annotated with which parties were "HFT". Besides the definition of "HFT" being very unclear, deciding if a trade was executed by an HFT firm (even by what he defines as a HFT trader) is very hard to determine.<p>The author utilizes the Market Participant ID (MPID) to try to determine the underlying firm for a trade, but this is not reliable. It is very common for many many firms to share a single MPID for "tier aggregation" since fees are calculated by MPID and the fees exchanges charge improve with higher volume. This means that many firms (HFT and not) can share a single identifier. Also, many large banks have a single MPID for all their flow, which may include HFT proprietary trading as well as non-HFT flow. He notes these flaws, but I am not sure he realizes how pervasive these arrangements are in the marketplace.<p>Even if he was able to determine the underlying firm for each trade, there is no rolodex of HFT traders. The author makes a valiant attempt using firm websites and such, but this process is somewhat error prone.

There's a lot of FUD surrounding the topic of high frequency trading (lowercase). Much more important to stability and sanctity of markets is transparency and effective regulation. Traders by design are trained to find inefficiencies to exploit -- that's how they make money. If some traders have discovered that by having computers trade really quickly, they can get an edge - well, that's kind of the point of trading. I think this paper is right to point out that high frequency trading has little to no impact on the overall marketplace.

<p><pre><code> The only function of economic forecasting is to make astrology look respectable. -- J K Galbraith:</code></pre>

At least in the abstract this study doesn't seem to differentiate between market making and more agressive HTF strategies, furthermore the firms involved and strategies they are running aren't listed. The potential bias in both these factors is enormous. Given there is significant empirical evidence that at least some HFT strategies have involved market manipulation and in one notable example, the temporary total destabilisation of the entire market I'm extremely dubious as to the origins and motivations behind this paper and the data used.<p>That the author appears to run a high-freq quant fund hardly helps: <a href="http://www.linkedin.com/pub/jonathan-brogaard/22/b04/b60" rel="nofollow">http://www.linkedin.com/pub/jonathan-brogaard/22/b04/b60</a>

Let's assume for a second that the author is correct and that correctly-executed HFT systems are generally a non-issue. Even with that core assumption, there is still the significant question as to what happens HFT systems misbehave (either due to suboptimal algorithms, bugs or a lack of adhering to stock trading good practices), which is the allegation that NANEX makes (<a href="http://www.nanex.net/20100506/FlashCrashAnalysis_Intro.html" rel="nofollow">http://www.nanex.net/20100506/FlashCrashAnalysis_Intro.html</a>).<p>Obviously, that isn't the subject matter that this paper is covering, but it definitely seems to be making an attempt to paint HFT as a Force for Good in the marketplace (or at least dispel attempts to paint it as a Bad Thing), and in my mind as a software developer, even more than impacts when things are Working As Intended, the bugs are what scare me.

Three most salient points of the paper offer an almost direct counter to HFT’s biggest critics:<p>- HFT activity has no impact on market volatility and may event decrease it.<p>- The authors find that there is no evidence of abusive front running.<p>- HFT plays an important role in price efficiency and the price discovery process.

<p><pre><code> Trading = Zero sum Investing != Zero sum</code></pre>