Does High Frequency (HFT) Trading Improve Liquidity?
High frequency trading (HFT) typically uses a few methods that include algorithms to help you decide when to move in and out of trades at the right time. This is referred to as high-speed trade execution. This allow you to spot opportunities when a particular stock is moving with increased volatility due to a high volume of purchasing and selling. These trades are ultra fast, usually measured in fractions of a second and combined with large stock movements can net you a profit. Many feel that HFT has helped the market liquidity as a result of narrowing the bid-ask spread. The argument being this also renders the market more fragile.
So, what is Liquidity?
Liquidity is measured a few different ways – Price, time and size. But there’s a little more to it. When there is high liquidity, traders can successfully execute large orders within a short time frame. Liquidity is the markets ability to absorb buy and sell orders at prices appropriate to supply and demand. The market and the trader must adapt quickly to these changes by processing this information for optimal results. It is said that liquidity is a key component to a good market as it results in confidence among Traders.
Over the past decade the popularity of HFT trading has greatly increased in the market. As HFT popularity was increasing so was market liquidity. It is now believed HFT trading makes up for over 50% of the trading volume. This includes banks, hedge funds, trading firms and yes, you and me. Around 2000 the alternative trading system (ATS) was introduced. Quickly gaining in popularity, use of the ATS ushered in a new system for buying and selling securities that has proven to open the market by making it more accessible to all who can participate. We now refer to ourselves as, “High Frequency Traders”.
We are the market makers and movers
HFT trading has resulted in the development of many trading strategies, which unarguably add liquidity to the market. One strategy includes HFT traders to execute orders on both sides of the stock trend simultaneously, providing opportunity for HFT traders to enter their trade at that time. This allows traders to incorporate the bid-ask spread into their strategy. With tighter spreads due to larger volume the HFT trader can execute in and out of a trade with better success giving greater confidence to the overall market. Also, HFT traders end up submitting and cancelling many orders for every transaction, which has led to many rebate opportunities. The volume of orders that are generated by HFT traders has led to incentives that have undoubtedly added liquidity to the market. Liquidity rebates in the equities market has led many traders to register as liquidity provider, which has resulted in a large drop in trading costs. The result has brought more participants to the market, which by definition adds Liquidity.
HFT here to stay
After a decade of positive results to the market high frequency trading is now accepted as part of the markets trading practices. HFT traders have proven to add liquidity to the markets and reducing trading costs. We must continue to evolve by improving our strategies and keeping to ethical practices, which will result in more confidence among traders that will likely grow and adapt with our trading style.