High Frequency Trading and Transaction Taxes

A growing number of trading and broking firms are now getting involved in High Frequency Trading (HFT), because for those who get it right, the profits can be huge. Ever hear the story of the goose that laid the golden egg? That’s what a successful HFT operation can be, a source of constant revenue and profit.

However, because the actual profits on a per trade basis are pretty miniscule (e.g. 1/10 of a cent per share), high frequency traders have to pump significant volume into the markets, day in and day out, to realize their profit objectives.

So what will happen to these HFT money-making machines if a new securities transaction tax is introduced? Yes, you guessed it, the goose will be stuffed!

Proposals have been put forward in US Congress by Rep. Peter DeFazio (D-OR) to introduce a transaction tax of 7.5c per share. At 75 times the current profit margin of the high frequency traders, this transaction tax if passed will kill their business stone dead.

Sen. Tom Harkin (D-IA) has proposed something similar in the US Senate, and both proposals are gaining support, even among many traditional long-only investors, who believe that HFT is bad for business and bad for the US equities markets in general.

It remains to be seen whether these bills will be passed and if so, in what form. One thing that the regulators will need to be careful of is that they don’t throw out the baby with the bathwater. Currently, HFT accounts for about 70% of total US equity trading volume. If it’s killed off, volumes are likely to suffer significantly and who knows what effect this will have on the US economy.

So it is a fine line that will have to be walked, between doing what is right for the market as a whole and taking things too far. Of course, even if these bills are passed, the big HFT firms might just take their business elsewhere, to Canada or the UK for example.

Also, according to the High Frequency Trading Review, HFT brings not just volume but also much needed liquidity to the markets. If this liquidity dries up, then all market participants are affected, not just the HFT firms.