HFT market makers raise costs for institutions - Pragma
The liquidity provided by high-frequency
traders in highly liquid stocks may be costing institutional investors more
than they think, according to new research from US-based trading technology firm Pragma.
According to the new white paper, the
combination of maker-taker pricing tariffs on exchanges and penny tick sizes
distorts the market and forces investors to subsidise the activity of
high-frequency trading (HFT) firms.
Pragma’s study looked at the
disproportionately long queues that are common when trading ultra-high liquid
stocks. Queues in these stocks, which are characterised by high volumes, low
volatility and narrow spreads, are a result of the huge number of HFT orders
competing to provide liquidity, which far outweigh aggressive orders.
This high proportion of passive orders
forces directional traders to cross the spread more often, increasing
institutional investors’ trading costs by several basis points compared to moderate
“Although competition among market makers narrows spreads, the research
note shows that reduction in spread is more than offset by the fact that market
participants are effectively forced to trade through unwanted intermediaries,
resulting in inferior execution prices,” read the paper.
stocks priced below US$1 have a narrower tick size and a rebate that is far
lower than those offered on stocks over US$1, which discourages HFT activity,
according to the paper.
“From a market
structure perspective, the concern is that there is no practical way to opt out
of interacting with these superfluous market makers, and because of the take
fees charged by exchanges, directional traders are effectively forced to
subsidise HFTs even though there are other directional traders they could
interact with directly,” the paper read.
To help improve
market quality for institutional investors, Pragma suggests regulators should
eliminate or limit the rebates offered by exchanges for providing liquidity and
reduce the tick size for stocks priced between US$1 and US$0.001. This, claimed
the firm, would help the market settle on more reasonable spreads in liquid
stocks and reduce profits made by HFT firms at the expense of institutional