Co-authored with Steve Krawciw
Traditional variables taken into consideration by investors have included growth prospects, competition, recent earnings, dividends, long-term volatility and the like. Fairly recently, investor relations began taking into account and explaining shorter-term market moves, such as the stock's responses to market-wide events. Lately, however, this information is no longer sufficient. Today's institutional investors increasingly care about the comparative intraday price dynamics of stocks, including participation of aggressive high-frequency traders and the stock's propensity for flash crashes.
Aggressive high-frequency traders are the ultra-fast mostly automated trading systems that are capable of swooping in and out of a stock at lightning speed. Aggressive high-frequency traders have been shown to worsen prices for investors when prices matter most, for example, immediately following meaningful news announcements leading to different price levels. Some academic studies have also linked higher aggressive high-frequency traders participation with higher stock volatility. When choosing between two stocks with similar characteristics, most investors prefer to invest into the stock with a lower participation by aggressive high-frequency traders to minimize execution costs and price slippage.
Flash crashes are manifestations of downward intraday volatility. These sudden drops in value, followed occasionally by equally sharp reversals, deter investors. Our firm's published academically-refereed research shows that flash crashes are not only predictable at least one trading day ahead of the crash, the flash crashes are like a curable microstructure disease, affecting some stocks, but not others. Again, when faced with two similar investing opportunities, most investors will select a stock with the lower likelihood of flash crashes.
As our firm's groundbreaking research shows, both the participation of aggressive HFTs and the propensity of a stock to have a flash crash can be influenced by carefully chosen corporate actions. Before any preventative measures can take effect, however, investors can perform due diligence to ascertain their chosen stock's vulnerability and portfolio risk.
In addition, investment professionals may want to track the participation of aggressive HFTs as well as the probability of a flash crash over time, as both metrics may evolve from one day to the next. For example, in 2014, the participation of aggressive HFTs in the stocks comprising the S&P500 averaged 23% by volume per trading day. Some stocks, however, had participation rates as high as 38%, while others had HFT participation as low as 9% by traded volume. In some stocks, like Kellog's, the participation of aggressive HFTs nearly doubled over the course of the year, while the aggressive HFT participation in some other stocks has fallen down.
Understanding intraday dynamics in one's stock are a necessary function of today's investment professionals. Following an unexpected crash, for example, investment professionals should be able explain the likely origin of the crash to investors, making everyone's jobs easier. Knowing participation of aggressive HFTs and flash crash probability in a stock can help to convince clients to do business.
Steve Krawciw is CEO of AbleMarkets.com, a web-based information resource that includes detailed analysis of aggressive HFT participation and flash crash predictability in all publically-traded financial instruments. Previously, Steve was business development executive with Credit Suisse as well as management consultant with McKinsey & Co. and Monitor. Irene Aldridge is Managing Director at AbleMarkets.com and author of High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems (2nd edition, Wiley, 2013).