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Are Flash Boys Becoming Too Efficient?
Perhaps the adage, “Time is money,” is no truer anywhere than in equity markets. Some new research into high frequency trading (HFT) by the UK’s financial regulator, the Financial Conduct Authority, has quantified how much money may be tied to minuscule amounts of time—its answer: $4.8 billion, which represents the estimated revenue traders make from capitalizing on “slightly out-of-date prices.” Flash Boys kind of stuff.
This particular flavor of HFT is called latency arbitrage. Improved technology and complex algorithms mean computers can make trading decisions in a fraction of a second. And the quicker a computer can make a trade—even by milliseconds—the more a trader can take advantage of price differences in the market.
Some will no doubt call for something to be done about this, particularly given this year’s US presidential election, which means proposed solutions abound—including, no surprise, a new tax. Another response (already in the works) is split-second delays in trade executions, or “speed bumps,” to help level the playing field.
Now, the issue may warrant some investigation—perhaps the playing field isn’t quite level. But first, it’s useful to put the $4.8 billion into perspective. Global equity markets finished 2019 with a total market cap of nearly $90 trillion. In the US, the average daily market volume last year was $322 billion. So latency arbitrage is a tiny slice of the trading pie. Any solution is likely to impose a cost—how the solution’s cost lines up with the problem’s is worth considering.
Then, too, mightn’t this be an instance in which the market ultimately sorts itself out? A prior study put latency arbitrage gains in 2014 at $3 billion for the S&P 500® Index alone. Other estimates also show declining costs.
Could it be the technological arms race to eke out millisecond advantages and profit from all existing market anomalies ultimately squeezes out such opportunities and makes the market more efficient? If so, it seems possible just about everyone could benefit in the long run.
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