June 23, 2010

High-frequency trading remains mired in controversy, with regulators fearing that unscrupulous traders are taking advantage of individual investors. But what critics don't realize is that high-frequency trading actually is beneficial to long-term investors and to the market at large, according to Arzhang Kamarei, managing partner at Tradeworx, a quantitative investment management firm with expertise in high-frequency market strategy.

"High-frequency trading creates opportunities for long-term investors by providing more liquidity," asserted Kamarei, who presented the keynote address at Wall Street & Technology's recent Accelerating Wall Street conference.

The extra liquidity that high-frequency trading provides, he explained, narrows spreads for long-term investors, ultimately helping them get better prices.

"During the turbulent fourth quarter of 2008, it was high-frequency traders that stepped up and provided liquidity," Kamarei argued. "High-frequency trading provides U.S. markets with better prices and deeper liquidity than markets in any other country or region. It helps smooth the course of long-term investors."

High-frequency trading is estimated to generate as much as two-thirds of U.S. equities daily trading volume. But as it grows in popularity, it also has attracted the scrutiny of regulators, eager to appease uneasy investors after the financial crisis.

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Addressing the controversy surrounding high-frequency trading strategies, Kamarei pointed out that high-frequency trading isn't always profitable. "High-frequency traders make money through spread capture," he noted. "They optimize adverse selection to match rebates. More volatility increases spreads."

In April, the SEC unanimously approved a new proposal that would track transactions by high-frequency trading firms to improve oversight of their activity. Under the new rule, firms will be given unique identifiers and will be required to report next-day transaction data when requested by regulators. This will allow authorities to keep closer tabs on traders that aren't registered market makers or broker-dealers without having to follow lengthy audit trails from exchanges when they scrutinize a particular firm or trade.