Founder and principal manager of AQR Capital Management Cliff Asness has been a vocal supporter of high frequency trading (HFT) since it first started receiving widespread attention a few months ago, and he is back a new editorial on Real Clear Markets (co-written by his colleagues Aaron Brown, Michael Mendelson, and Hitesh Mittal) defending HFT.
“The debate has not calmed or moved on to more constructive discussions of market microstructure as we suggested. While a number of large asset managers have now made statements supporting HFT, new charges against HFT continue to gain prominence,” he writes.
‘Front-running’ is just order anticipation: Asness
The new charges they’re referring to are that HFT is too consistent (making money essentially every day), that it involves illegal front-running, and that it provides false liquidity. HFT is consistent because it relies on the bid-ask spread, as market-makers have done for as long as there have been markets. Comparing market makers to traders is bit misleading, but Asness’s defense doesn’t address the real question behind the criticism: is HFT intermediation really necessary in the first place?
The issue of illegal front-running is more complex, but Asness focuses on whether or not HFT strategies are currently illegal, as opposed to whether they’re good for the market.
“Most of what is being talked about as ‘front running’ is really just the legal, ethical and economically beneficial practice of order anticipation, which is a fancy word for educated guessing,” he writes.
Asness gives the example of a trader putting the same block of shares of for trade on two different exchanges, and then taking it down when it sells on one or the other, but this is pretty far removed from the complex layering strategies used by HFT, and critics wouldn’t give HFT firms the same benefit of the doubt that Asness does.
Liquidity is central to criticism of HFT
But the third question is really the most important. If HFT supplies liquidity to the market and reduces bid-ask spreads, then it provides a useful service that justifies intermediation and order anticipation. If the liquidity is fake, then it’s hard to see how taxing the system and making the market microstructure so much harder to understand is really worthwhile.
Since market makers are willing to stand on either side of a trade, they don’t make money by having better information or analysis than the next guy. They can rely on the bid-ask spread to cushion market moves to some extent, but competition prevents them from pushing too far in this direction.
“Widening the bid-offer spread will mean that the HFT will lose the order flow to market makers with tighter bid-offer spreads,” writes Asness. “That is why, in the equity markets, HFT market makers turn to order anticipation. They try to figure out (again educated guessing, not knowing!) what kind of trail a typical informed trader leaves while executing his order.”
Ultimately, Asness’s is unlikely to change anyone’s mind on HFT because it he assumes it provides liquidity and then argues that the tactics that come along with that benefit are ethical, while critics believe this liquidity is fake and that HFT firms are getting paid without providing anything of value.
