Does High Frequency Trading add value to the market?

Reading Mark Cuban’s post about High Frequency Trading (HFT), indeed, I agree with him that it provides little value to the marketplace.

The incentives are completely geared toward having it, however – the stock exchanges make money on volume and have no incentive to stop it. The traders themselves are able to do it profitably and have no incentive to stop.

The easy solution to fix this problem is to simply transform the stock market into one second auction windows – i.e. every second that the stock market is open (6.5 hours, which translates into 23,400 seconds) bids and asks are aggregated and transactions are appropriately processed.

This would also undermine the value of sub-penny quotations and seriously reduce the value of phantom quotations that try to “probe” what hidden support there is in the order book.

There would be a decrease in volume, but most of the volume you see today is “phantom liquidity” – it is liquidity that would never be truly accessible for somebody wanting to accumulate or distribute shares at a certain price level.

This change is unlikely to be enacted, however, since it does nothing politically for those that control the securities commissions – the regulators’ incentive structure is favoured toward higher complexity, and thus more requirements for regulation.

More specifically, securities regulations has little to do with “investor protection” – rather, it is about entrenchment of established interests.