What Percentage of U.S. Equity Trades Are High Frequency Trades?

Several financial analysts have said that some 70% of American stock trades are high frequency trading:

• The former head of Nasdaq said that high frequency traders account for 73% of the volume on the stock market

• Joseph Saluzzi - partner and co-head of equity trading for Themis Trading - puts the figure at 70%
  

• As does market analyst Peter Cohan

• And Raymond James analyst Patrick O’Shaughnesy*

• And Senator Ted Kaufman
  

But the exact figure is difficult to ascertain.

One of the leading companies trying to estimate the percentage of HFT trades is the TABB Group. (Indeed, the former head of Nasdaq cited above was quoting TABB's statistics.)

TABB's research director, Adam Sussman, wrote in October 2009:

Most HFT prop shops choose to keep their identities and intentions secretive, operating under the radar in the hope of improving their chance to profit.

***

The only art more forgivable than economic forecasting is estimating the market size of an industry that will never reveal its true number.

As of last October, Sussman estimated HFT to account for 61% of trades:

TABB Group estimates that high-frequency trading accounts for 61 percent of U.S. equity share volume (remember to double-count average daily shares!) and generates $8 billion per year in trading profits.

The methodology begins with an analysis of institutional equity trading volume that we have been collecting since 2006 from 115 U.S.-based equity head traders, including equity assets under management, average daily volume and the percentage of shares executed in blocks. We extrapolate that data to the broader institutional landscape. Retail trade numbers and data from the government are used to determine retail flow. Data from NYSE and Nasdaq and historical market making volumes enhances our picture of current electronic market-making volumes. Last but not least, we discussed our methodology and trading profit calculations (.0024/share) with several HFT hedge funds, independent high-frequency traders and registered market makers.

Sussman provided the following chart showing that its not just stocks, but that futures, options, bonds and currency are also traded using HFT:

However, earlier in the year, TABB released a 32-page report with 22 exhibits entitled "US Equity High-Frequency Trading: Strategies, Sizing and Market Structure", which placed the figure at 70% (revising the figure down from 73%):

Based on updated volume and trading data shared in the report, TABB Group revises its estimate of US equity trading volume to 70% from 73% as previously announced in July 2009 in a TABB commentary written by Iati, "The Real Story behind Trading Software Espionage," covered by financial and business media around the world.

"Throughout the report you'll find results of an August 2009 poll of 62 market participants on various components of current market structure," adds Sussman, "including flash trading, redefining front running, the tradeoff between order exposure and price improvement and the need for an SEC inquiry into market structure and the ability to achieve good execution.

So is it 70% or 61%?

As Cristina McEachern Gibbs notes, its both:

Recent TABB Group estimates indicate that 70 percent of U.S. equity trading volume, or 61 percent of share volume, is a result of high-frequency trading.

But how does TABB Group arrive at these numbers? Iati explains that there is a large amount of information available in the public domain, including information on assets under management (AUM) at hedge funds and retail order flow. The Westborough, Mass.-based advisory firm combines this publicly available information with proprietary data culled from its institutional research studies, such as average daily volume (ADV). Those numbers are then applied to the broader universe of trading stats. "We have our own sample as a proxy and use our sample of AUM and ADV to help model the broader marketplace," Iati says.

But a September 13 article from CNBC shows that that figure has declined since last year:

Total daily volume in all stocks listed at the New York Stock Exchange went from about 2 billion shares a day five years ago, to an average of about 5 billion shares a day today. High-frequency trading now accounts for about 56 percent of trading volume, according to Tabb Group, but Tabb notes that this figure includes market makers. Five years ago, it was practically nothing.

Who's trading? Here's the latest breakdown of daily volume (source: Tabb Group):

• High-Frequency Trading: 56 percent (includes proprietary trading shops, market makers, and high-frequency trading hedge funds)

• Institutional: 17 percent (mutual funds, pensions, asset managers)

• Hedge Funds: 15 percent

• Retail: 11 percent

• Other: 1 percent (non-proprietary banking)

Gibbs notes that not everyone agrees with TABB's numbers:

Though sophisticated, TABB Group's methodology is not an exact science, and the industry's high-frequency-trading numbers are still up for debate. Woodbine's Samelson pegs high-frequency trading at about 40 percent of overall market volume today, with electronic trading accounting for up to 70 percent of total equity volume. According to Samelson, however, it is extremely difficult to put a dollar amount on this volume. Joseph Mecane, EVP and chief administrative officer for U.S. markets at NYSE Euronext, estimates that at least half of the liquidity in the market is generated by high-frequency trading or automated market making.

The bottom line is that unless the government forces reporting by traders, it will be difficult to shine a light into the high frequency trading world bright enough to determine what the exact numbers are.

* As Barry Ritholtz notes, Peter Cohan was quoting Patrick O’Shaughnesy, and O’Shaughnesy told Ritholtz that the range might actually be somewhere between 50-70%.