A retailer works on the floor of the New York Stock Exchange.
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Traders and hedge funds who use high-speed methods to acquire an advantage in the stock market impose a “tax” on other investors, according to a study released Monday, costing as much as $5 billion per year across international exchanges.
The Financial Conduct Authority (FCA), a regulatory arm of the United Kingdom, found that the trading practice, known as “latency arbitrage,” creators the overall volume of trading on global stock markets to decrease.
Latency arbitrage is one of the ways high-frequency traders profit to the hurt of slower trading investors. It involves arbitraging prices gleaned with a low latency – in fractions of a second – from sure exchanges. Better prices are snatched up by high frequency traders before regular investors. The arbitrage practice also has the capacity of reducing the incentive for those on the other side of a trade to offer these better prices, which also expenses retail participants.
The FCA found the average race between firms lasted 79 microseconds (79 millionths of a secondly), faster than the blink of an eye, with only the quickest to execute its trade gaining any benefit.
While each hop to it only yielded small wins for traders, the FCA’s study tracked 2.2 billion such races over the direction of just 43 trading days on the London Stock Exchange. In all, more than 20% of the total trading size the FCA tracked was found to come from these latency arbitrage races.
“In aggregate, these small races add up to valid harm to liquidity,” the FCA’s study said. “Our main estimates suggest that eliminating latency arbitrage would drop the cost of trading by 17%.”
The Wall Street Journal first reported the study’s results.
The FCA study looked at trading occupation from August 2015 to October 2015. Although the report did not identify the institutions using this method, the FCA set that six firms won latency arbitrage races 82% of the time.
While latency arbitrage trades on public info, the study found the negative outcome of such high speed trading is that it increases the cost for investors to buy and exchange shares. While the FCA’s study focused on U.K., its authors said they hoped “other researchers and regulatory authorities replicate our interpretation for markets beyond UK equities.”
“To our knowledge, most regulators do not currently capture message data from exchanges, and the markets seem to preserve message data somewhat inconsistently. We hope this will change,” the FCA said.