high frequency trading

High Frequency Trading: Illegal, Unfair, Or A Necessary Tool?

High-frequency trading (HFT) uses algorithms and speed to rapidly trade securities and make money. With little regulation or transparency, it’s a wild west world where techies run the show.

In rural England two competing companies want to build their own 1000 foot communication towers to speed trading information between London and Europe.  In India techies have shaved trading time down to 6 microseconds – that’s 0.006 thousandths of a second – as regulators fret about unknown risks. In the US, a whistleblower gets $750,000 for reporting HFT misdeeds by the New York Stock Exchange.

Here’s a look at how HTF works, and the controversy surrounding it.

What is high frequency trading?

HFT is a type of robotic trading through which computers make market decisions in milliseconds, based on instructions generated by algorithms.

According to Forbes, these HFTs are programmed to buy stocks when the price is below the trend, and then sell them when they’re above the trend to increase profits. A good HFT is programmed to observe all incoming prices, crunching the data at lightening fast speeds to make accurate decisions based on real market trends.

What are the arguments against it?

Since the rise of HFT, many have complained that the practice hides the identity of large buyers and sellers, denying transparency and fair access to the market for smaller traders.[contextly_auto_sidebar id=”FwHqjeVvWE6LHdW7mx0cHr5P15P3YDk5″]

Other issues include the difficulty of regulating trades at such high speeds, and the instability and risk they create which has contributed to market crashes in the past, most notably in the flash crash of May 2010.

In that case, when one trade took a dive, the HFTs slowed trading – a fallout that greatly exacerbated the crash.

Michael Lewis’ now famous book, Flash Boys focuses on HFTs’ front-running, or jumping in between orders to take a cut of the action, quickly, when there are discrepancies in prices. This aspect doesn’t create liquidity, the Atlantic says – instead, it’s “superfluous financial intermediation.”

If in general HFTs do create liquidity, it’s not attributable to front-running. In addition, the speed of HFTs means they are competing against each other in fights that don’t end in trade, waste talent and money, and actually decrease liquidity, according to the Atlantic piece.

High Frequency Trading benefits to ordinary investors

All of this is not to say that HFT is without its benefits. There have always been middlemen front-running trades; it just happens that today those middlemen are unregulated algorithms.

And overall, HFTs do benefit traders of all sorts by eliminating the gap between what buyers want to pay and sellers want to be paid. It’s also lowered prices overall, improved efficiency, and added liquidity, many argue.

HFTs pour resources into the market, and the more they pour the more exchanges and transaction fees improve for all investors.

There is also the argument that if security exchanges are selling HFTs data access and speed, it’s similar to HFT airplane passengers opting to sit in first class while regular investors opt to sit in coach for less – HFTs pay for that advantage.

Updated

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