The publication of Michael Lewis’ Flash Boys in April, 2014, generated an intense wave of publicity surrounding high frequency trading (HFT) firms, much of it unfavorable. Earlier this year, the high-frequency trading firm Virtu Financial LLC published details about the firms long-term operations in an SEC filing. One remarkable fact stood out like a sore thumb in the company’s filing: The firm had suffered just “one losing trading day” in over 1,238 days of trading. Let me write that again slowly — high-frequency traders Virtu Financial made profits with their high-frequency trading scheme on 1237 out of the last 1238 days over the last five plus years.
Enough trades at 51% winners and you can’t lose
You might well ask, “How can this be?”, and the answer is statistics. As Greg Laughlin, professor of astrophysics at the University of California at Santa Cruz, points out, even if you only win 51% of your trades, if you make enough trades you are statistically certain to make profits.
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And, yes, Virtu did make a lot of trades. Laughlin calculates that Virtu traded around 160 million shares a day during the period, close to 3% of the total daily volume in all U.S. equity markets, as first reported by Bradley Hope of the Wall Street Journal. Laughlin also noted that trading volumes were somewhat lower during the period described in Virtu’s SEC filings, and so on higher volume days, Virtu’s trading would have represented more than 5% of the total US equity market.
Doing some further calculations, Laughlin determined that Virtu was making around 800,000 trades day. He concludes by highlighting that with 800,000 trades a day, it is literally statistically impossible for Virtu to have a losing day.
Laughlin concludes by saying his calculations make it clear that Virtu’s one losing day “resulted from either a technological or human-caused error.”
Extrapolating Virtu data to overall HFT industry provides interesting insights
Professor Laughlin takes things one step further, extrapolating Virtu’s data to the entire HFT sector. He calculates that current HFT U.S. income on equity trading is ballpark $10 million per day and $2.5 billion per year (not counting fees and technology costs).
Potential regulation of high-frequency traders
Federal securities regulators continue to consider further regulation of high-frequency traders. In remarks made last week, SEC Chairman Mary Schapiro made it clear that the SEC is looking at the practice of high-frequency trading and the impact on the markets. “The flash crash was a huge wake-up call for regulators about the frailty of our market structure,” Schapiro noted. “Investors should bear the risk of their investment. They should not have to bear the risk of whether the markets are functioning fairly.”