The Possible Long-Term Benefits of High-Frequency Trading

High-frequency trading remains mired in controversy, with regulators fearing that unscrupulous traders are taking advantage of individual investors. But what critics don't realize is that high-frequency trading actually is beneficial to long-term investors and to the market at large, according to Arzhang Kamarei, managing partner at Tradeworx, a quantitative investment management firm with expertise in high-frequency market strategy.

"High-frequency trading creates opportunities for long-term investors by providing more liquidity," asserted Kamarei, who presented the keynote address at Wall Street & Technology's recent Accelerating Wall Street conference.

The extra liquidity that high-frequency trading provides, he explained, narrows spreads for long-term investors, ultimately helping them get better prices.

"During the turbulent fourth quarter of 2008, it was high-frequency traders that stepped up and provided liquidity," Kamarei argued. "High-frequency trading provides U.S. markets with better prices and deeper liquidity than markets in any other country or region. It helps smooth the course of long-term investors."

High-frequency trading is estimated to generate as much as two-thirds of U.S. equities daily trading volume. But as it grows in popularity, it also has attracted the scrutiny of regulators, eager to appease uneasy investors after the financial crisis.

Addressing the controversy surrounding high-frequency trading strategies, Kamarei pointed out that high-frequency trading isn't always profitable. "High-frequency traders make money through spread capture," he noted. "They optimize adverse selection to match rebates. More volatility increases spreads."

In April, the SEC unanimously approved a new proposal that would track transactions by high-frequency trading firms to improve oversight of their activity. Under the new rule, firms will be given unique identifiers and will be required to report next-day transaction data when requested by regulators. This will allow authorities to keep closer tabs on traders that aren't registered market makers or broker-dealers without having to follow lengthy audit trails from exchanges when they scrutinize a particular firm or trade. Melanie Rodier has worked as a print and broadcast journalist for over 10 years, covering business and finance, general news, and film trade news. Prior to joining Wall Street & Technology in April 2007, Melanie lived in Paris, where she worked for the International Herald ... View Full Bio

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