By Barbara Cohen
While HFTs may argue that they bring liquidity to the Market, they cannot dispel the concerns that liquidity comes at a very high price to investors – increased volatility. In a report issued in September 2011, associate professor Frank Zhang of Yale University stated that once an instrument’s share volume exceeds 50%, trading becomes basically a “hot potato,” as HFTs trade the same positions, passing them back and forth amongst themselves. Inter-firm trading all but eliminates “Price Discovery,” determining share price by normal supply and demand factors, such as news events or positive/negative earnings releases.
Inter-firm high frequency trading also wreaks havoc for Main Street investors because of “cross spreading.” So many liquid stocks, such as BAC and MSFT, now execute in milliseconds, resulting in extreme “competition” for Main street investors. Queues to enter and exit are significantly longer, with hundreds of shares waiting to execute. Long queues force Main Street investors into the vulnerable position of having to buy at the offer or sell at the bid, a trading method known as “crossing the spread.”
via How High Frequency Trading Robots Are Creating a Bumpy Ride for Main Street – NASDAQ.com.
As far as I can tell the root cause to “hot potato” trading is leverage/credit. As far as the effective wash trade among HFT algos, the skyrocketing ratio of algo quotes to actual trades suggests that the wash among speculators is not increasing – at least not proportionally. Further to that point, you can go back to reminisciences of a stock operator to show that spec-ing does in fact lead to the range breakouts that mark price discovery. As to retail investors having to cross the spread, well that’s what separates the market makers from the end users (investors). The alternative is to trade on the curb. I don’t know what the modern day equivalent to that would be other than otcbb but I wouldn’t want to have to sell my portfolio on craigslist.
…just my 2 cents…
..or you could buy at the open if there is an opening auction. At least that way there is little opportunity for algos to inject themselves between buyers and sellers.