HIGH FREQUENCY TRADING
price impact should be measured; whether current measures should be adjusted to account for the increase in the speed of execution, and whether these measures adequately capture an investor’s cost of executing a trade.
Conclusions HFT has been evolving for more than a decade and was brought
to the limelight by the Flash Crash and the news that HFT firms are earning billions in profits. According to the Tabb Group, HFT firms as a group earned
... regulators first need to evolve their
regulatory surveillance systems to effectively monitor the impact of HFT
Finally, the authors consider an
alternative parameterization where HFTs charge the same haircut per trade, and the effect is an increase in the number of traders. This suggests that the overall effect on the “true liquidity providers” in not at all clear. To ascertain the impact on
liquidity, therefore, there is a need for developing a proper empirical framework to: (a) determine the speed-cost relation on outside investors and liquidity traders;
(b) determine if HFTs are raising the cost of business for market makers; and,
(c) if they do, whether the liquidity they provide is a good substitute for the one that is being driven out.
The authors conclude that while
HFTs clearly generate costs, they also generate benefits, and hence the net effect is still ambiguous. A more recent study by Hasbrouck and Saar (2011)8
attempts to provide
a response to the above dilemma. After studying NASDAQ’s trading data, the study infers that low- latency trading (HFT) improves traditional market quality measures such as short-term volatility, spreads and displayed depth in the limit order book. Notably, while there have been suggestions that HFT may have played a role in the infamous “Flash Crash” of 6th
May 2010, research
based on the day’s trading data has acquitted HFT firms. As such, a study by none other than the CFTC’s chief economist Andrei Kirilenko et al found no evidence to link the flash crash to HFT.
78 March 2012
$12.9 billion in profit in 2009 and 2010. As big profits through HFT began to be heard more loudly across market circles, regulators across the globe (and especially in the US) began pondering on whether HFT actually added anything to market efficiency or added an unfair advantage. The regulatory scrutiny thus intensified after the Flash Crash and although regulators refrained from
blaming high-frequency traders for directly causing the massive sell-off, there have been allegations that some HFT firms may have exacerbated the decline by switching off their machines and withdrawing from the market.9 Despite HFT being highly debated – even as research studies in
this field are still preliminary in nature – regulators are already inclined to crackdown on computerized high-speed trading based largely on the apprehension that HFT exacerbates market swings. Notably, swayed under the pressure of a global economic slowdown, regulators seem to be adopting a conservative approach in dealing with these evolving practices. Whilst a conservative approach is not totally uncalled for, it should not become restrictive without being backed up by empirical evidence. Hence, in the field of HFT, where research activities are still at a preliminary stage, any ill-thought out regulatory directives could sound the death-knell on evolving HFT. Instead, the regulators first need to evolve their regulatory surveillance systems to effectively monitor the impact of HFT rather than just gunning down their speed or outlawing them altogether. •
Dr Nilanjan Ghosh is Senior Vice President and Head of
Research & Strategy Multi Commodity Exchange of India Ltd., in Mumbai.
E:
nilanjan.Ghosh@
mcxindia.com
Niteen Jain and Nazir Ahmed Moulvi work as Senior Analysts with MCX.
E:
niteen.jain@mcxindia.com E:
nazir.moulvi@
mcxindia.com The views expressed here are personal
www.mcxindia.com
Footnotes:
1 Speech by Mr Andrew G Haldane, Executive Director, Financial Stability, Bank of England, at the International Economic Association 16th Beijing, 8th
World Congress, July 2011.
2 Easley, D., M. López de Prado, M. O’Hara, The Microstructure of the ‘Flash Crash’: Flow Toxicity, Liquidity Crashes and the Probability of Informed Trading, The Journal of Portfolio Management, Vol. 37, No. 2, pp. 118–128, Winter, 2011.
3. Concept Release at 3607-10, SEC (US). 4. Sheppard, David and Spicer, Jonathan, High-frequency trade fires up commodities, June 2011.
5 High-frequency trading Better than its Reputation, Feb 2011, Deutsche Bank Research.
6. Fabozzi , Frank J., Focardi, Sergio M. and Jonas, Caroline. High Frequency Trading: Methodologies and Market Impact, 2011, Review of Futures Markets, Vol 19 Special Issue.
7. Cartea, Álvaro and Penalva, José, Where is the Value in High Frequency Trading?, 2010,
http://ssrn.com/abstract=1712765.
8. Hasbrouck, Joel and Saar, Gideon, Low-Latency Trading (2011). Johnson School Research Paper Series No. 35-2010, AFA 2012 Chicago Meetings Paper.
9. Spicer, Jonathan, Globally, the flash crash is no flash in the pan (2010).
www.reuters.com/article/2010/10/15/us-flashcrash-europe
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