The Growth of High Frequency Trading
The US equities markets are changing, and changing in a big way.
Although volumes are ballooning, you may be surprised to learn that average order sizes are actually getting smaller. The average order placed on the New York Stock Exchange is now just about half the size it was five years ago.
Why is this?
The reason can be put down in large part to the growth of high frequency trading, where orders are submitted electronically into the market at high speed by proprietary trading firms looking to capture multiple small, short-term profits.
In order for high frequency trading strategies to be effective, the orders they submit have to be small enough to skim best bid and offer prices without adversely moving the markets. And to counter these high frequency trading activities, institutional fund managers (who are usually on the other side of the trades) have to chop their big block orders up into smaller and smaller chunks so that they don’t “show their hand”.
Put all of that together and you will see why, despite the massive growth in the number of shares traded, order sizes continue to get smaller.
However, according to the folks at the High Frequency Trading Review, one of the downsides to this paradigm is the resultant increase in overall trading costs, particularly the post-trade costs. Clearing and settlement costs are generally calculated on a per trade basis, so obviously it is going to cost substantially more to clear and settle ten trades fo a thousand shares each than it would for one trade of ten thousand shares.
The cost implications to the wider market that have come about with the growth of high frequency trading is just one of the many issues being addressed by the SEC in its latest consultation paper, which seeks to comprehensively review the US equities, futures and options markets.
The concern is that the playing field has become increasingly uneven. The SEC is seeking to implement far-reaching regulations to bring greater equilibrium to the markets’ structure.
Public comment on the consultation paper is due by April.
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