Raining on Their Parade (by Bill Harts, Modern Markets Initiative
This month, a study was presented by two professors at Wilfrid Laurier University that looked at the effect of rain, sleet and snow on U.S. trading quality. A simple interpretation of its findings by modern market critics led to a string of jubilant comments touting that when bad weather slows fast trading, market prices improve, so therefore slower trading must be better. I thought, maybe we’d even have a new Wall Street adage: “When weather’s a fright, spreads are tight.” But all kidding aside, a closer reading of the study reveals it to be very supportive of why modern markets need to be encouraged, freely accessible and widely available.
Over the past twenty-five years, a small group of traders, technologists, physicists, mathematicians and professionals from diverse areas of science and finance have come together to make trading exceptionally efficient and cost-effective for all. As their innovations have been introduced, tweaked and then widely adopted, it has created the best markets ever for investors by any measure (such as cost, quality and stability). The Wilfrid Laurier study supports these historical facts by proving that the widespread adoption of HFT tools has helped eliminate the inefficient speed differentials between market participants that raise costs.
The study looks at three phases of the introduction of microwave linkages to markets: 1) before microwave usage, 2) when microwaves were available to only a small group of trading firms, and 3) when microwaves became widely available, and access to them “democratized.” What the study found is that when the markets evolved from phase 1 to phase 2, some measures of market quality declined. But when the market moved to phase 3, market quality was restored, rain or shine.
The study states that “As a result (of widespread microwave access), the advantages previously enjoyed by select firms that had access to microwave networks were diminished. We find that once information transmission is democratized in this manner, adverse selection, trading costs and volatility decline.”
A core principle of MMI is Fair and Equal Access. Those who read our website understand that, “Markets should promote fair and equal access for all market participants. A level playing field, without unnecessary barriers to entry for investors, allows them to compete effectively. When HFT tools are available to all, market quality improves.” This study backs that up 100 percent.
It may not be the most sensational interpretation, but I think a more accurate reading of the study is that when as many market participants as possible are able to use HFT tools, costs to trade are reduced. I realize this puts a damper on the parade of tweets and blogs demonizing the improvements HFT tools have brought to investors. But, the fact is that this study actually proves that when all investors have access to faster markets their quality is better. ‘Weather’ it’s raining or not.