What is the quantitative evidence regarding the presence of aggressive high-frequency traders (HFTs) in today's markets? Our firm's AbleMarkets Aggressive HFT Index tracks the participation of aggressive HFTs in real-time and offers some interesting observations. As 2014 rolls to a close, we are able to offer comprehensive statistics on tick-by-tick, minute-by-minute and hour-by-hour evolution of aggressive HFT participation during this past year, as well as daily statistics presented in this article.
Why does aggressive HFT participation matter? Multiple academic studies have confirmed that aggressive HFTs worsen market conditions for institutional investors. The aggressive HFTs are not to be confused with the passive HFTs, as the passive HFTs have been shown to improve liquidity in the markets, while the aggressive HFTs tend to worsen liquidity conditions. As a result, large trades in stocks with higher aggressive HFT participation obtain worse prices than do trades in comparable stocks with lower aggressive HFT interest, among other problems. Understanding aggressive HFT participation in securities of interest may help institutional investors lower execution costs and generate higher investment returns as a result.
How prevalent are the aggressive HFTs in the stocks comprising the S&P 500? According to AbleMarkets research, over the past year aggressive HFTs accounted for 23 percent of traded volume, on an average trading day across all the S&P 500 stocks. Out of those, Google (NASDAQ:GOOGL) was most popular with aggressive HFTs, averaging close to 38 percent of aggressive HFT participation in the volume traded. Frontier Communications (NYSE:FTR), on the other hand, was the stock with the minimum aggressive HFT participation, of just nine percent by volume on an average trading day.
As for the changes in the aggressive HFT participation, over the past year, the proportion of high-frequency traders across the S&P500 stocks has remained stable, gaining just 0.20 percent in buying activity and one percent in selling activity across all 500 equities. The changes in participation, however, vary dramatically, with some stocks shunning the aggressive HFT attention, and some gaining the aggressive HFT interest. For example, aggressive HFT participation in Kellog's (NYSE:K) and Linear Technology (NASDAQ:LLTC) on an average trading day has doubled, to 30 percent and 27 percent, respectively. On the other hand, the aggressive HFT participation in NaviSite (NASDAQ:NAVI) has two thirds of the way to 14 percent.
The proportion of aggressive HFTs further varies from day to day and from stock to stock. Over the past year, the stock with most day-to-day variation in the aggressive HFT participation was Graham Holdings Company (NYSE:GHC), varying on average up to eight percent from one day to the next. Aggressive HFT participation in Avon Products (NYSE:AVP), on the other hand, held mostly steady at just over 12 percent.
What drives changes in aggressive HFT participation? The data shows that market capitalization, the metric commonly thought to affect aggressive HFT interest, has no link with the extent of aggressive HFT participation. Stocks with U.S. $100+ Billion in total shares outstanding have comparable aggressive HFT interest as do stocks with single digit billion market cap among the S&P 500 stocks. Similarly, little evidence links aggressive HFTs and stock volatility. There is weak evidence of a link between stock prices and aggressive HFT participation. The causality of the relationship is not clear: whether aggressive HFTs favor stocks with higher prices, or stocks gain more value as a result of aggressive HFTs remains to be seen. AbleMarkets is continuously studying HFT behavior and the ways investors can capitalize on this information and increase their returns.
One point is clear-cut, however, it pays to know the up-to-date aggressive HFT participation in each stock. Faced with two stocks with similar risk and return characteristics, investors seeking to enhance their performance may want to select the stock with the lower aggressive HFT participation rates to substantially improve their execution costs. Savings on execution costs can amount to several percentage points per year, even when the portfolio is reallocated quarterly or even less frequently.
Irene Aldridge is Managing Director of Able Alpha Trading, LTD., an affiliate of AbleMarkets (http://www.ablemarkets.com). Aldridge is a recognized expert on High-Frequency Trading, and author of "High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems" (Wiley 2013), now in its second edition. She can be reached by email at ialdridge@ablealpha.com.