balanced somewhere else, and when we unwind, it doesn’t affect the market either.” By this he means that forced selling by quant funds may be painful for the funds themselves, but that pain is barely reflected in the market, because the funds’ long and short positions–positive and negative bets on the direction of given securities–cancel one another out. “We don’t take from the retail guy,” he says. “We make the market more efficient. Things are better for the retail investor because of high-frequency trading.”
Narang, and academics like Donefer, say that high-frequency traders are making money by delivering a service: liquidity. In today’s highly decentralized market, defenders say, their systems are simply the most efficient way to match buyers and sellers. And because they can capitalize on small differences between the prices at which a seller is willing to sell and a buyer is willing to buy, those differences stay small. The upshot is that retail buyers pay a little less to buy a share and can sell it for a little more. Indeed, since electronic trading has come to dominate the market, spreads between buying and selling prices have decreased dramatically, and so have fees. Ten years ago an investor might have paid $150 in fees to trade 500 shares with a broker, facing a spread of maybe a dime on each share. Today’s retail investors pay $10, with spreads of a penny or so in most big stocks, and most of their trades are filled almost instantly.
Understanding how high-frequency trading improves liquidity explains a lot about why many such traders do well when the market is plunging or volatile, as it was last year. “We don’t make volatility happen,” says Narang. “We reduce it, but it is how we make our money. We create order. When the markets are disorderly, we make a lot of money, but we are doing it by restoring the markets to order.”
If Narang is right, the new ways are good for the retail investor. But the argument that high-frequency funds improveliquidity, as if they were providing a public service, is disturbingly reminiscent of the justifications offered by hedge funds and banks that created complicated derivatives in the years leading up to the recent crash. When things went bad in that case, the liquidity disappeared–along with many of the funds invested in them, and much of the investors’ money. And this type of history doggedly repeats itself. Wilmott, for one, is not convinced that high- frequency trading is useful to the economy. “People have to say things are fine because they’re being rewarded for it,” he suggests.
At least for now, though, things are calm, and the spreads are narrow. After lunch, Narang’s day at Tradeworx starts to get busier as hundreds of high-frequency funds jostle to close out their positions to their best advantage. Narang says good-bye at the door, his words the only sound in the quiet office. On the wall behind him, Tradeworx’s daily profit-and-loss line still ticks up and down, but mostly up.
Bryant Urstadt is a writer based in New York.