STOCK MARKET WATCH -- Wednesday, 26 December 2012

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10. High-Frequency Trading Prospers at Expense of Everyone

http://www.bloomberg.com/news/2012-12-25/high-frequency-trading-prospers-at-expense-of-everyone.html

Finally, a bit of evidence, rather than anecdote, about the costs of high-frequency trading.

In a new study, Andrei Kirilenko, the chief economist at the U.S. Commodity Futures Trading Commission, along with researchers at Princeton University and the University of Washington, examined high-frequency trading in a futures contract called the e-mini S&P 500, between August 2010 and August 2012.

The study looked at only the expiring contracts (which trade electronically on the Chicago Mercantile Exchange) that are used to bet on the direction of the Standard & Poor’s 500 Index. The researchers also did something they’d never been able to do before: Use actual trading data from individual firms, though none were identified.

What that data does is help explain the frenzy in today’s markets: The most aggressive firms tend to earn the biggest profits, hence the incentive to trade as quickly and as often as possible. Furthermore, these traders make their money at the expense of everyone else, including less-aggressive high- frequency traders.

The study found that the most hyperactive trading firms earned an average daily profit of $395,875 in the e-mini S&P 500 contract over the two-year period. First and foremost among those on the losing end: small retail investors. The study found that, on average, they lost $3.49 on every contract to aggressive high-frequency traders.