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High Frequency Trading

I am not on top of the relevant literature but wonder whether high frequency trading is partly responsible for the extraordinary volatility of global stock markets in recent times. In some cases firms are transmitting thousands of stock market orders per second. 2 out of 3 stock market trades in the US are of this form. The particular difficulty in markets like the Australian market where volumes are relatively low – and have been particularly low in recent times – is that such trading can drive prices.

I would be interested In views on this from those who are more knowledgeable on this subject. Recent trends seem strange to me and not adequately explained by oscillating views on the seriousness of the European situation and the strength of the US economy. There is a mixed empirical literature on the effects of high frequency trading on volatity – some suggests it reduces volatility. But I don’t know of literature that examines the same issue in a bear market where the possibility of a secular decline in prices would seem to create incentives for strategies to manipulate prices.

10 comments to High Frequency Trading

  • ken n

    Yes, someone has probably done some work on this.
    At the moment, I still buy what I think is the conventional view that more traders and traders flattens volatility. But I’d like to see evidence or argument to the contrary.
    The volatility could be explained by the presence of risks – big ones – on many fronts so there is a lot of news (will they/won’t they kind of stuff) as well as re-assessments of likely outcomes.
    Interesting times…

  • hc

    Ken, I am a market participant rather than an expert in this area. But the day-to-day price shifts now occurring look like something is going on. Quite a few phony rallies and then inwvitable selloffs.

  • conrad

    Surely if they were doing that, then the next generation of algorithms would learn to take advantage of the older ones.

  • BendigoSean

    Increased liquidity (tends to) leads to lower volatility. HFT not only changes (increases) the liquidity of the market but also “viscosity” of the market. Probably not the right “academic” term but viscosity is a good anology for whats happening. Markets are normally highly viscous, low transaction costs etc, but the high speed/low-latency (the algos are physically placed close to the exchange to reduce time lags) of HFT pushes the market viscosity into a super-viscous phase where strange things happen much like superfluids in physics…

    and when the nature of markets change quicker than regulation/oversight, market manipulation tends to occur…

  • anon

    More volume should mean less vol not more. The vol is being caused by the market attempting to figure out what Europe means and also discounting a significant slowdown that was never expected at the beginning of the year.

    No one has a clue where NGDP is going to end up. Hence the jerks. There will be years of this.

  • anon

    And if anyone suggests HFT should be banned, if you can even define it in a way that isn’t damaging to the market, should also tell us if the pigeon carrying information about the French/English war should have been banned.

  • Boris

    “In the U.S., high-frequency trading (HFT) firms represent 2% of the approximately 20,000 firms operating today, but account for 73% of all equity trading volume”

    from this link http://en.wikipedia.org/wiki/Algorithmic_trading heard an interview a week or so ago. No longer the market a measure of emotion like before (unless machines are emotional). And just goes to show how amazingly digital it has all gone.

    “At the turn of the 21st century HFT trades had an execution time of several seconds, whereas by 2010 this has decreased to milli- and even microseconds.”

    From http://en.wikipedia.org/wiki/High-frequency_trading

    The machines are competing with each other!

  • observa

    With online trading and up to the minute pricing do you simply get a perfect market like metro petrol pricing? To the extent that any online trader has instant access to buy/sell offers, the traditional sharebrokers have no better insight nor the ability to match buyers and sellers. Hence the oscillating marketplace, whereas before they had a dampening effect on such movements, albeit they were not allowed to say it out loud.

  • observa

    Gawdelpus! The high frequency mob in Canberra have unleashed the thin air derivatives traders-
    http://www.businessspectator.com.au/bs.nsf/Article/Camel-cull-could-limit-climate-change-MQFEF?OpenDocument&src=hp14
    Lucky for flying foxes they’ve got small arses by all accounts but the rest of us need to cover ours bloody well now.