How Not to Fall Prey to the Flash Boys

Not only are high-frequency traders not trading as fast as expected, they only impact a fraction of the market, according to Abel/Noser.

High-frequency trading (HFT) adds more noise than liquidity to the market, and institutional investors should try to save costs elsewhere, according to trading analysis firm and transition manager Abel/Noser. 

“HFT is really engaged in a game of ‘liar’s poker,’ trying to fake out the market to score a profit,” the firm said in a new report. “HFT, other than market makers, does little to improve the liquidity of stocks.”

The firm’s analysis of stock trading and liquidity in the US found most HFT focused on large or mega-cap equity. And the most liquid trading instrument in the US—State Street’s SPDR S&P 500 exchange-traded fund, accounting for 6.4% of all traded stocks—traded only 5 times a second in November, slower than normally expected of HFT.

“When you read articles about HFT, you’d think that stocks are being traded 1,000 times per second,” Abel/Noser’s President and CEO Bill Conlin told CIO. “In reality, it’s not trading that fast.”

In addition, the analysis revealed that every trade in the US equity market in November saw its quoted price change 33 times.

“Quotes used to mean something when trades were done slower, say, over the phone,” Conlin said. “But now because quotes are changing very rapidly, they become meaningless when you go to put in the trade.”

Through such rapid-fire changes, Abel/Noser’s analysis said nearly 97% of all quotes in stocks are cancelled—with no trade ever being made. And more “nefarious” high-frequency traders—detailed by Michael Lewis in his book Flash Boys—flood the market with excessive quotes “just to gain informational advantage to trade on it,” Conlin said.

Institutional investors shouldn’t get caught up in the HFT hype, the CEO added.

“They have bigger fish to fry,” he said. “While there are those high-frequency traders who manipulate the market in this way, they only impact a fraction of the stock market.”

Instead, investors should focus on saving costs in the process of how a manager approaches the market, Conlin suggested, ensuring he or she is aggressive in the right place and time.

The excessive hype of high-frequency traders may have also translated over to the entertainment business. Leaked emails from Sony Pictures Entertainment revealed Flash Boys is unlikely to be made into a motion picture because it was “too research-intensive” and without an obvious plot.

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