Today, Ray Pellechia posted the following defence of High-Frequency Trading on the official NYSE blog:
The debate regarding high-frequency trading has become muddled by confusion over high-frequency trading itself, which generally provides liquidity to the market, and flash-type orders. The NYSE agrees that flash order types are not in the market’s best interests, but disagrees with those who try and lump that activity with beneficial high-frequency trading.
One predicted beneficial effect of High Frequency Trading (HFT), should be lower quoted spreads (the difference between the bid price and the offer price on a stock), in stocks where high-frequency activity is common. High-frequency traders tend to be most prevalent in the highest-volume stocks, because such stocks afford more opportunities to execute high-frequency strategies, with lower risk.
We compared average quoted spreads on the NYSE in the top 100 NYSE-listed issues (by share volume) in the 2002-2006 time period, with data since April 2007. This represents pre- and post-Reg. NMS (excluding the January – March 2007 period, just before and just after implementation of required exchange routing). We used these periods because we assume that high-frequency trading became more common following Reg. NMS implementation.
There are many factors that impact quoted spreads: individual stock news, market microstructure and overall market volatility. The below chart shows volatility (as measured by the S&P 500 VIX®) is a major factor in spreads (click chart to enlarge).
We adjusted for variations in VIX by breaking the historical spreads into categories based on several VIX buckets: VIX below 15%, VIX between 15% and 25%, VIX between 25% and 35% and VIX between 35% and 45%. Although VIX rose above 45% during the height of the market’s volatility last year, we have no comparable period between 2002 and 2006. Our research shows that for similar levels of VIX, spreads in high-volume NYSE stocks on the NYSE narrowed between 7.5% and 46.4% from the before to the after period.
The story is similar for Nasdaq issues. Although the profile differs, based on VIX levels, spreads for Nasdaq’s highest volume stocks fell between 6% and 48% during the same time period.
We do not see a positive impact for spreads across all issues. NYSE spreads only narrow for levels of VIX below 15%, and Nasdaq spreads improve for VIX levels below 25%. In all cases, even where there is an improvement, it is far smaller when measured across all stocks than for high volume stocks only.
The table below summarizes the statistics for NYSE and Nasdaq (click table to enlarge):
Conclusion: Spreads have narrowed since.Reg. NMS implementation for the highest-volume stocks on both the NYSE and Nasdaq, after adjusting for similar levels of volatility, as measured by the CBOE VIX index. We chose Reg. NMS as a break point because it represented a major change in how all exchanges routed and also approximates the time when NYSE moved to an electronic market. We acknowledge that Nasdaq trading was more heavily electronic in the 2002-2006 period than NYSE trading, but expect that high-frequency trading increased across all venues.
We do not see a similar pattern when spreads are averaged (equally weighted) across all NYSE or Nasdaq stocks. We use all stocks as a proxy for lower-volume issues, since the highest-volume issues make up a very small share of all issues. Equal weighting essentially emphasises low-volume issues. Spreads generally widened averaged across all NYSE and Nasdaq stocks, during periods of similarly high volatility, and narrowed during the least-volatile periods.
Although the NYSE’s new market model may have had some positive impact on higher-volume stocks, the similar lower-spread experience on Nasdaq-listed issues, we believe, validates that HFT is likely a positive factor in market quality for high-volume issues, where these participants are present. The lack of across-the-board spread improvement in lower-volume issues, where HFT is less present, further highlights the generally positive impact from this activity.
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