HFT and the Stability and Fairness of Markets
High Frequency Trading (HFT), the process of buying and selling small groups of securities at infernally fast speeds, has become one of the easiest ways of ensuring gains for a fund’s customers. Specially designed complex algorithms read and react to market trends in milliseconds, acquiring and dumping stock before a mere human would even know it has happened. Only small gains might be made on each trade, but the speed at which the trades can be made, combined with the scope a speed at which a computer can read market trends, means hundreds of trades done in only seconds. It is low-end retail philosophy applied to market trading: massive quantities of low gain trades.
The increase in both network speeds and computing power has meant that those with available capital, usually large hedge fund management companies, can invest in the expensive labour and hardware required to achieve these alarming trading speeds. And they are! Although it is estimated that only 2% of firms in the US are engaged in HFT, they account for over 70% of daily trading. When so few can account for so much market activity, and such high entry costs prevent others from participating, one surely has to reassess whether equality of opportunity is still at the heart of the American Dream insofar as it relates to the stock market.
Other traders are now also complaining of a reduced confidence in the fairness of the market caused by HFT. Most large investors try to mask their actions using various methods in order to not be headed off. But the most complex of HFT algorithms are capable of reading trends with a speed, precision, and scope that no trader could possibly achieve, granting a significant advantage. Not surprisingly, some investors have reported dissatisfaction at the potential for their trades to be headed off. The speeds at which these algorithms are capable of acquiring data and reacting to trends have raised serious questions over whether fair markets can be maintained while some traders engage in HFT.
Not only has fairness been a concern, but HFT introduces new volatility challenges that are extremely hard to predict. There is a potential for rogue algorithms, in other words algorithms which behave other than intended. And the speed at which other HFT engaged firms respond to these missteps can exacerbate one mistake almost instantly. No mere hypothesis, this phenomenon has already been seen once, when on May 6 a Midwestern mutual fund company’s HFT algorithm mistakenly dumped a significant number of stocks. The HFT algorithms of other firms had read this stock dumping as a sign to sell, and many pulled completely out of the market. In less than four minutes the DOW crashed more than 600 points, its fastest decline ever.
Not only is the use of HFT granting unfair advantages to those who have the upfront capital to acquire such systems, but it introduces a level of unpredictable volatility which has been known to quickly explode in to a flash crash. As more of us rely on investments for our retirement and education savings, this volatility in the market has great effects on our own future, putting it further out of our control. HFT is only one of many American Dream games changers effecting the equality of opportunity which America has always espoused. Over the next few weeks we’ll take a look at a few more ways technology is changing the American Dreamscape, including some which are putting hope back in to the prosperity and freedom of the United States.
<i>with files from the International Organization of Securities Commissions (www.iosco.org) and The Wall Street Journal (www.WSJ.com).</i>