A key metric to determine if the cost to trade is getting lower, is to see how tight “spreads” are. This is the price difference between buyer and seller when negotiating a sale. The larger the difference, the greater the compromise and the worse the final price will likely be for both parties. Since the adoption of HFT, which continuously surveils the market and aligns pricing across venues, this difference has become much smaller, saving large and small investors alike hundreds of millions of dollars for their retirement and other savings accounts.
How Does HFT lower Costs?
A series of regulatory changes beginning in the late 1990’s, fostered the emergence of a new type of professional intermediary, high frequency traders (HFTs). Whereas traditional market makers had one trader at a keyboard covering 15-20 stocks, efficient HFTs could use computers to trade thousands of stocks simultaneously. Automated systems allowed HFTs to earn profits competing on razor thin margins of fractions of a penny per share rather than the 5 or 10 cents per share traditional Wall Street traders were accustomed to making. The end result has been much lower trading costs that help investors keep more money in their retirement and stock savings funds.
Industry Support for the Role of HFT in Saving Investors’ Money
Vanguard CEO Bill McNabb says HFT firms had helped investors cut their trading costs, and urged the US Securities and Exchange Commission not to reverse the market reforms that gave birth to the phenomenon.
– Financial Times interview with Vanguard CEO Bill McNabb
“(HFT is) working to tighten spreads and enhance liquidity … (investors) benefit by getting lower transaction costs. That results in hundreds of millions of dollars a year in savings to investors in our funds.”
– Gus Sauter, Retired Chief Investment Officer, Vanguard Group
“Main Street is the great beneficiary … We are better off with high-frequency trading than we are without it.”
– Jack Bogle, Vanguard founder, pioneer of low-cost investing
“Trading has never been easier and costs never lower thanks to human intermediaries being rendered obsolete.”
– Robin Wigglesworth, Financial Times
“In the decade of migration to electronic trading and HFT arrival, transaction cost decreased by over 50% for both retail and institutional investors.”
– Albert J. Menkveld, Professor of Finance, VU University Amsterdam
“By providing so many bids and offers, high frequency trading firms have narrowed pricing spreads. Spreads for almost every financial instrument are substantially less than they were a decade ago. For example, spreads in most US equities are half of what they were 10 years ago.”
– John Servidio and Bo Harvey, McGuireWoods LLP
“From an institutional or buy-side perspective, today’s markets are more efficient than anytime in the past. Today’s markets are faster, they’re cheaper to trade, the typical buy-side desk has more choice due to competition in terms of execution venues, whether they’re block trading systems or dark pools, registered ATSs, and algorithms that we can customize that allow us to navigate electronic markets and obtain the best possible price for our fund shareholders.”
– Bill Baxter, Fidelity’s Head of Global Program Trading and Market Structure
“The world should be measured the following ways: The spread between bid and ask, and the commissions charged to do a transaction, are so dramatically smaller today — they’re measured in thousandths of a penny sometimes compared to when I was in the securities business.”
– Michael Bloomberg, founder and CEO, Bloomberg, LP
“High-frequency trading in general has been good for the retail investor.”
– Fred Tomczyk, CEO, TD Ameritrade
“Overall, HFT enhances market liquidity, reduces trading costs, and makes stock prices more efficient.”
– Charles Jones, Columbia University professor, study analyzing 30 papers on HFT
“As HFT activity has grown over the past 15 years, we have observed decreases in both implicit costs and explicit costs, such as brokerage commissions. The end result is the ability to deliver more cost-efficient investment solutions to our clients.”
– Dimensional Fund Advisors
“Researchers found that Canadian bid-ask spreads increased by 9 percent in 2012 after the government introduced fees that effectively limited HFT.”
– The Atlantic magazine
We’ve come down nearly two orders of magnitude in that bid ask spread in the past 30 years. From around 0.20 percent to some 0.002 percent. That’s saved every investor huge amounts of money over all the trades they’ve done.
“[Electronic market making] brings tangible benefits to our clients through tighter spreads”
– BlackRock Viewpoint
“How do we feel about high-frequency trading? We think it helps us.”
– Cliff Asness, Founding Principal, AQR Capital Management
“… the increased use of electronic trading has brought many benefits, such as more efficient execution and lower spreads.”
– Timothy Massad, CFTC Chairman
“Numerous studies – including the recently released UK Foresight HFT project – have shown that transaction costs for both retail and institutional traders decreased substantially with the growth of high-frequency trading.”
– Larry Harris, USC Marshall School of Business, former chief economist at SEC 2002-04
“HFT provides many clear benefits, such as more market liquidity and generally lower transaction costs for participants. Speed by itself is not bad. Regulators and the industry need to tackle more appropriately market manipulation, which may happen in low-frequency as well as high-frequency trading environments.”
– Dominique Cerutti, Former president and deputy chief executive of NYSE Euronext
February 19, 2017: High Frequency Trading: The Path Forward for Market Liquidity and Stability
McGuireWoods capital markets attorneys John Servidio and Bo Harvey discuss the benefits of high frequency trading in the securities and derivatives markets.
July 19, 2016: How a Small Group of Traders Improved Markets for All (Video)
MMI CEO Bill Harts gives a short history of how market intermediaries that use high frequency trading tools have made trading cheaper and more efficient for investors.
June 2016: The Economics of High-Frequency Trading: Taking Stock
Professor Albert J. Menkveld conducted a survey of the academic literature on HFT. He read 100+ manuscripts to identify the economic arguments for and against HFT. He concludes that electronic markets and HFTs arrived and coincidentally transaction costs declined for investors. This suggests the identiﬁed economic beneﬁts of HFTs outweigh their economic costs.
January 21, 2016: Op-Ed Why U.S. investors are better off today
Hal Scott, professor of international financial systems at Harvard Law School and director of the Committee on Capital Markets Regulation, writes that “U.S. investors are actually much better off in today’s high-speed automated marketplace.” He cites transaction costs for retail investors that have been cut in half since 2007 and mutual fund giant Vanguard estimates that “$10,000 invested in a mutual fund over 30 years would now yield a long-term investor $132,000 instead of $100,000.
June 2015: High-Frequency Trading around Large Institutional Orders
Professors Vincent Van Kervel and Albert J. Menkveld find that HFT provides liquidity for six hours to large buy side orders, to their benefit, and in doing so challenges the belief that HFT profits from quick “electronic front-running.” This prolonged period of HFT leaning reduces institutional trading costs by 39 percent and by extension all the individual investors they represent.
Dec. 1, 2014: SEC Division of Economic and Risk Analysis – Automated Liquidity Provision
The authors create a model showing how automated HFT liquidity providers set more efficient prices, increase informed and decrease uninformed traders’ transaction costs, and have no effect on volatility.
November 8, 2010: paper – Choking the Recovery
Harold S. Bradley, former head of trading for American Century Mutual Funds, co-authors a paper that finds, in 1988, the typical market maker netted about four cents in profit for every share traded. In contrast, the typical HFT today reportedly nets 7/100 of a cent or less for every share traded. In short, the HFTs are willing to work for 98 percent less than what the average market marker of yesteryear made.
June 2, 2010: Statement of George U. Sauter, Managing Director and Chief Investment Officer, The Vanguard Group at SEC Market Structure Roundtable
We think that much of the recent controversy surrounding “high frequency traders” and “dark pools” reflects a general lack of understanding of the benefits that such participants bring to the markets. Based on decades of experience, it is our belief that high frequency trading and dark pools contribute to a more efficient market that benefits all investors. Generally speaking, high frequency traders provide liquidity and “knit” together our increasingly fragmented marketplace resulting in tighter spreads that benefit all investors.
April 21, 2010: Vanguard Comment letter on SEC Concept Release on Equity Market Structure
“…we conservatively estimate that transaction costs have declined 50 bps, or 100 bps round trip. For example, if an average actively managed equity mutual fund with a 100% turnover ratio would currently provide an annual return of 9%, the same fund would have returned 8% per year without the reduction in transaction costs over the past decade. Today’s investor with a 30 year time horizon would see a $10,000 investment in such a fund grow to approximately $132,000 in 30 years, compared to approximately $100,000 with the hypothetical return of 8% associated with the higher transaction costs. Thus, any analysis of “high frequency trading” must recognize the corresponding benefits that long-term investors have experienced through tighter spreads and increased liquidity.
August 18, 2009: Paper – Algorithmic Trading and Information
Berkeley Professors Terrence Hendershott and Ryan Riordan examined three weeks of automated trading and identified that algorithmic trading “contributes more to the discovery of the efficient price than human trading. Contrary to conventional wisdom we find no evidence of AT behavior that would contribute to volatility beyond making prices more efficient.”
TIMOTHY MASSAD, CFTC Chairman
June 3, 2015 Speech