Friday, December 23, 2011 07:19 AM
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The Mixed Blessings of High Frequency Trading
By: Barry Elias
Several days before the “Flash Crash” of May 6, 2010, I exited the equities
market, as described in my Moneynews article of May 6, 2010.
Exactly one year later, my article described how high frequency trading
(HFT) actually increases volatility, despite the opposing rhetoric
promulgated by the financial industry.
The reason:
HFT intentionally generates price movements away from the market
equilibrium, forcing them to return back to that initial point.
This dynamic creates enormous price movements, or price volatility, which
reduces liquidity. It also generates large trade volume, revenue, and profit.
The basic premise:
At any given time, someone is willing to pay a different price for a particular
product than the market price. HFT permits the trader to locate that buyer,
thereby creating a new price that does not reflect the broad market.
Eventually, market forces return the price back to its initial setting.
This return process is typically aided by HFT, which exacerbates the move
beyond the initial equilibrium, further increasing price volatility.
The European Securities and Markets Authority (ESMA) is concerned that
the excess orders and messages created by HFT may cause systemic risk
to the financial markets. As a result, they have embarked on a study to
determine the effects on liquidity by HFT.
This dynamic has been clear for some time.
The reactive and myopic assessment of HFT by ESMA and the U.S.
Commodity Futures Trading Commission (CFTC) is a microcosm of the
global misappropriation of precious resources.
The resultant malinvestment precipitated a global financial cataclysm that
will likely take decades to mend.
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