“Speed bumps,” or slight delays in trading, can help protect most investors from the predatory tactics employed by high-frequency traders, according to a new study by an economist for the U.S. Securities and Exchange Commission.
The study published on Wednesday by financial economist Edwin Hu does not represent the views of the SEC or its commissioners. But it does provide a new data point in the continuing debate about market structure and lends some support to the business models of upstart exchanges such as U.S.-based IEX Group Inc. and Canada’s Aequitas Neo Exchange Inc.
High-frequency traders (HFTs) use lightning-fast computers that allow them to execute millions of trade orders and scan multiple exchanges in seconds. The logic behind speed bumps is to prevent those traders from profiting off that speed advantage.
One of the strategies that such traders employ is to get other investors to reveal what they want to buy or sell.
For example, if HFTs discover that an investor wants to buy shares of a particular company that they are offering to sell, they can quickly rescind their offer and resubmit it a fraction of a second later at a higher price. Several exchanges have implemented delays in an attempt to stop this.
Mr. Hu based his research on IEX, which has a speed bump that delays orders by 350 microseconds before executing them. IEX also pauses updates to its market-data feed.
Mr. Hu studied U.S.-listed stocks that were heavily traded on the IEX and compared them against those that were not. His research found that the spread between the bid and ask prices was lower for the stocks that were frequently traded on that exchange, suggesting that its speed bump is effective for those stocks.
Jos Schmitt, president and CEO of Aequitas, said he is not surprised by the findings. After all, the company’s business model is also predicated on the notion of delaying high-frequency traders and reducing trading costs for regular investors.
Aequitas, which was launched in 2015, even draws its name from the Latin word for equality and fairness.
Since the launch of the Neo exchange and the IEX, a number of larger exchanges have introduced speed bumps or started exploring the idea, including the TSX Alpha exchange owned by TMX Group Ltd.
But Mr. Schmitt noted that not all speed bumps are created equal, and that regulators will have to examine them on a case-by-case basis. Some exchanges apply speed bumps differently than others do.
“There will always be different views around this and different interests at play, and you will always have people that will push back on it because it doesn’t fit with their strategy and what they want to do,” Mr. Schmitt said.
“Will the debate end with a paper like this? No, it’s one person at the end of the day … but at the same time, I think the SEC has been clear that they were very comfortable with the IEX speed bump, and this study seems to confirm that this was the right decision.”