High-frequency trading (HFT) firms make money – and lots of it – by exploiting inefficiencies in the pricing of shares quoted on several exchanges in an increasingly fragmented marketplace. They also generate significant income by capturing rebates offered by various exchanges for providing liquidity. While detractors dub such practices as abusive and predatory – claiming, for instance, that HFT firms engage in rebate arbitrage without providing liquidity – HFT supporters assert that such high-volume trading adds liquidity and shrinks trading spreads. Rather than wade into the raging HFT debate, our objective here is to determine which stocks HFT firms like to trade – the smaller-capitalization, volatile ones that gyrate on a daily basis, or the large-cap blue chips that have more price stability?
Ideal Stock Attributes for HFT
Traders of all stripes – including HFT firms, proprietary traders and day traders – prefer to trade stocks that have heavy trading volume, since this translates into narrower bid-ask spreads and abundant liquidity. Such stocks typically also have substantial share float, as this implies a greater number of shares that are free trading.
But two additional stock attributes are uniquely suited for HFT:
- Low volatility – The typical trader likes high volatility because large price swings mean more profit opportunities, but not the high-frequency trader. HFT firms prefer stocks with low volatility, because their trading philosophy is based on making tiny amounts of profit on very large orders thousands of times a day. Although greater volatility may mean more potential reward, it also carries a higher degree of risk. The high-frequency trader prefers a trading environment where small amounts of profit can be made with near 100% certainty, to one where larger amounts of profit can be made with a lesser degree of certainty.
- Low stock price – While a typical trader may be indifferent to the price of a stock, price is an important determinant of whether a stock is suitable for HFT. This is because rebates are based on the number of shares traded, so for the same amount of funds deployed in a trade, an HFT firm can earn a larger total rebate on a lower-priced stock than on a higher-priced stock. For example, assume a high-frequency trader has $25 million to deploy in a trade that will earn the firm a rebate of $0.001 per share for offering liquidity. If the HFT deploys the $25 million by buying 5 million shares of Stock A trading at $5, rather than buying 0.5 million shares of Stock B trading at $50, the firm will earn a rebate of $5,000 ($0.001 per share x 5 million shares) by trading stock A instead of $500 through stock B.
Favorite Stocks of the HFT Crowd
The year or two after the bull run commenced in March 2009 was the ideal environment for HFT, since such a large number of blue chips were trading at single-digit and double-digit levels. One stock that was a hot favorite among HFTs was Citigroup, which was trading below $5 for most of the two-year period from March 2009. The stock was very heavily traded during that time, with average trading volume per day of more than 500 million shares from March to May 2010, according to a study on HFT stock favorites by Stamford, Conn.-based Woodbine Associates.
The Woodbine Associates study released in June 2009 identified 25 stocks that were favorite trading targets for HFT firms, based partly on average daily trading volume from March to May 2009. Citigroup, the overwhelming favorite, was followed by Ford Motor, although Ford’s daily volume of 133 million shares was only slightly more than a quarter of trading volume for Citigroup.
The other stocks on the HFT favorites list were – Bank of America, General Electric, Intel, Pfizer, Sprint Nextel, Microsoft, Cisco Systems, Wells Fargo, JPMorgan Chase, Las Vegas Sands, Alcoa, AT&T, Oracle, Regions Financial, Exxon Mobil, Fannie Mae, Motorola, Yahoo!, Dell, EMC, Apple, Morgan Stanley and Home Depot (ticker symbols and links to quote pages are in the chart below).
Are These the Current HFT Favorites?
To identify which stocks may be the current HFT favorites, a logical starting point would be the Russell-3000 Index, one of the broadest indices of U.S. stocks. Using the following three attributes – price below $50 (a somewhat arbitrary benchmark to identify relatively low-priced stocks), beta of less than 1.5 (which would include stocks whose volatility is not more than 50% higher than the broad market) and market capitalization of at least $50 billion (the biggest blue chips) could give an efficient approach for identifying current stocks suitable for HFT.
The results shown in the table below depict stocks with the parameters previously mentioned as of May 2014 ranked on ascending order of price. The 24 shares on the table show high liquidity, float of at least 1 billion shares and float as a percentage of total outstanding shares exceeding 90% for most of them. Daily volume as a percentage of total averages 0.6%, which means that total trading volume over a full year (250 working days) would be 1.5 times the float.
On an interesting note, a little over half of the 2010 Woodbine list appears on the current list of 24 stocks. These include – Bank of America, Ford Motor, Cisco Systems, Intel, EMC, General Electric, Pfizer, Morgan Stanley, AT&T, Microsoft, Oracle, Citigroup and Wells Fargo. While Bank of America and Ford Motor may be the top two HFT favorites, former top favorite Citigroup has been relegated to a much lower position consequent to its 1-for-10 reverse split in March 2011. As a result, its 30-day average daily trading volume in May 2014 was less than 20 million shares (compared with over 500 million four years ago).
A little under half of the 2010 favorites are not featured on the 2014 list for a number of reasons – huge increase in share price from 2010 to 2014 (for example, Fannie Mae, Las Vegas Sands, Home Depot, Apple, Yahoo! and Exxon Mobil); companies acquired or restructured (Dell, Motorola, Sprint Nextel); or simply because the underlying sectors, like commodity producers and banks, are no longer as hot as they were in 2010 (Alcoa, JPMorgan Chase, Regions Financial).
Some of the 2010 favorites may have been replaced by a few that have emerged with a new identity in recent years – Abbott Laboratories (which spun off part of its business into AbbVie in January 2013), Mondelez International (spun off by Kraft Foods) and General Motors (re-emerged from its 2009 bankruptcy). Other stocks that could be current HFT favorites are – Hewlett-Packard, Twenty-First Century Fox, Coca-Cola, Altria Group, US Bancorp, Bristol-Myers Squibb, Verizon and Dow Chemical. Note that triple-digit stocks like Google and Apple are unlikely to be HFT favorites due to their steep price.
|Stock||Ticker||Market Cap.||Price||Shares Out.||Float||Float/Shares Out.||Beta||Avg. Daily Vol.||Daily Vol./Float|
|($ billion)||(22-May-14)||(billions)||(billions)||(%)||(one-year)||(million shares)||(%)|
|Bank of America||BAC||$154.05||$14.71||10.53||10.51||99.8%||1.18||94.20||0.90%|
What About the Most Volatile Stocks?
On the flip side of the volatility scale, 11 stocks are classified as the most volatile in the Russell-3000 Index based on their beta over the past year. But while they satisfy the heavy-trading volume and low-price criteria, their volatility and relatively smaller float may make them less appealing for HFT trading.
The 11 most volatile stocks in the Russell-3000 as of May 2014 are – SunEdison, Yelp, Xoma, WisdomTree Investments, Career Education, Maxwell Technologies, Celldex Therapeutics, Trulia, Education Management, Ziopharm Oncology and Cytokinetics. Yelp is the highest priced of these 11 stocks, of which five trade in the single digits.
But only SunEdison and WisdomTree have a float in excess of 100 million shares, and only five of the 11 have a market capitalization above $1 billion. However, daily volume as a percentage of float is exceedingly high for most of these stocks, led by Yelp (12.6%), Cytokinetics (6.7%), Trulia (5.6%) and SunEdison (5.2%). Despite these trading levels, these stocks' volatility may restrict their appeal to HFT firms, except perhaps for the biggest stocks such as solar company SunEdison and online directory Yelp.
The Bottom Line
Contrary to popular belief, high-frequency traders prefer to trade lower-volatility blue chips – such as the 24 stocks shown as examples here – rather than their smaller and more-volatile counterparts. A good and simplistic approach for identifying potential high-frequency trading stocks is to look for low-price stocks, high market capitalization and low volatility.
Disclosure: At the time of this publication, the author had long positions on: Pfizer, Yahoo, and Bristol-Myers Squibb.