On May 6, 2010, following concerns about debt crisis in Greece, the DJIA to plunged roughly 9% in five minutes. Twenty minutes later, the market had regained most of the drop (1). High frequency trading (HFT) is credited for playing a major role in this flash crash. The simple fact is computerization of Wall Street is happening rapidly; HFT firms are responsible for about 50% of trading in the U.S. equities market (2).
High-frequency trading uses computers to make trades at lightning speed. Firms that employ HFT say users are merely harnessing available technology to make trades, resulting in increased price efficiency (3). Some market observers also emphasize that high frequency trading is simply faster trading, and that many of the trading strategies used by HFTs are not new, therefore nothing has changed in the economics of the market (4). Critics, however, say HFT leaves other investors at an unfair disadvantage and that it can be disruptive, with liquidity drying up suddenly when markets turn volatile and trading programs shut down (3). Furthermore, studies on low-latency activity – strategies that respond to market events within milliseconds – show that the algorithms involved are so fast that detect, analyze, and respond to a market event within 2-3 milliseconds (4). These statistics question the relationship between the interplay of algorithms and market dynamics; how can human traders accurately recognize the current state of the market if the speeds of market interactions occur too fast for human comprehension?
As for flash orders, some critics describe it as a way for a firm – and exchange – to hack the system. Technically, it is legal, and it barely makes it by the National Market System (NMS) regulations established by the SEC. The rationale for flash orders: better me than you. They allow a venue to execute marketable orders in-house when that market is not at the national best bid (NBBO) or offer instead of routing those orders to rival markets. They do this by briefly displaying information about the order to the venue's participants and soliciting NBBO-priced responses. If there are no responses, the order can be canceled or routed to the market with the best price (5).
I'm not entirely sure how to feel about this topic. It's new to me, and I feel like I have a lot more to learn before I can prove valuable to a discussion. My initial reaction was "heck, it's capitalism, right?" Technology and innovation has removed or significantly decreased the human factor in all industries. There are factory's run by some sort of sophisticated technology that make automobiles and package our food and prescription drugs. I suppose the true question is how much responsible do we want to put in the "hands" of a computer when it comes to our money? We feel safe about computers running the production plants that make our cars and package food, why is it different in finance?
Josh
References
(1) Lauricella, Tom (May 7, 2010). "Market Plunge Baffles Wall Street -Trading Glitch Suspected in 'Mayhem' as Dow Falls Nearly 1,000, Then Bounces". The Wall Street Journal. p. 1.
(2) http://online.wsj.com/news/articles/SB10001424052702304887104579302681366721324
(3) http://blogs.marketwatch.com/thetell/2014/01/15/europe-plans-crackdown-on-high-frequency-trading/
(4) Tarun Chordia, Amit Goyal, Bruce N. Lehmann, Gideon Saar, High-frequency trading, Journal of Financial Markets, Volume 16, Issue 4, November 2013, Pages 637-645, ISSN 1386-4181, http://dx.doi.org/10.1016/j.finmar.2013.06.004.
(5) http://www.highbeam.com/doc/1G1-203482971.html
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