HFT is Insatiable - its Hidden Costs
Requires expensive capacity increases, puts the market at risk every minute of every trading day
We have spent the last 24 years working with real-time
market data on a tick-by-tick basis. We monitor our commercial datafeed in
real-time to stay on top of market changes or issues. This past year, we have spent
considerable time and effort studying the relentless growth
of equity quotes. Based on our findings, virtually all of the additional quotes contribute
zero or negative economic value to stock pricing, because they are either way outside
the market or end up
expiring before any investor or trader could possibly act on them.
Furthermore, we can't find any self-limiting mechanism in place that
will ever put a stop to this unnecessary and
growth of misinformation. The only thing that prevents a sudden explosion in quote
traffic is the capacity limitation set by SIAC which
Consolidated Quote System (CQS) for the exchanges.
Every 3 months or so, SIAC increases the capacity limitation for CQS. Shortly
after each increase, often the next trading day, quote rates will surge to new record
levels and completely fill the new capacity. The chart on the right beautifully
captures this phenomenon: it shows the 2
ms peak quote rate for CQS on 30 minute intervals over each trading
day since July 2010. Recent dates are colored towards the red end of the spectrum: older dates towards the violet. The gaps between
groups of lines chronicle the immediate jump in quote traffic after the capacity limit
is raised. The gap between the green and orange groups occurred after the limit was raised on
July 5th: traditionally one of the quietest trading sessions of the year. The lone green line near the 600,000 level marks the only time when it took more than a day to hit the new limit. See if you can distinguish between the quiet trading days of July and the
tumultuous trading days of August among the orange group.
When CQS capacity
fills, new stock quotes are placed in a queue to prevent loss. In a
trading environment running at the speed of HFT, most of these quotes will end up
expiring before exiting the queue. In effect, when quote
traffic is high, most of the additional quotes will be canceled long before
a trader or investor receives them. And quote
traffic is often highest when reliable information is most important.
Extra capacity is vital for times of market stress from surprise news events or shocks
to the system. The lack of capacity during these times will quickly lead to a drop
in liquidity as
traders pull out from lack of clear pricing information. This was a
major cause of the
We understand that market makers and
HFT need to adjust their
quotes to fast changing market conditions. But 10,000 times per second per symbol,
or more, in an
inactive stock? Every
quote has a non-zero cost: millions of computers and miles of network cables must process and transport each one, costing both time and energy. Sending quotes and then canceling them
before they ever leave the exchange
network is absurd.
We think we found a possible solution to the HFT/non-HFT divide that lets the market
itself decide the value of an equity
quote. The solution is incredibly simple and has virtually
zero impact on the millions of systems already in place. It also requires
no cancellation fees or transaction taxes, and it lets trading go as fast as the speed of light.
The chart below shows 2 ms peak quote rates on 1 minute intervals, illustrating
often capacity limits are hit.
Publication Date: 10/14/2011
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