Regulation and HFT

Terry Flanagan

Market participants assert that macroeconomic factors, and not high-frequency trading, are to fault for the market instability.

While many market observers are looking to regulators to rein in high-frequency trading and its effects on the trading landscape, it was regulators that originally caused the inception of the high-speed trading practice. Regulation NMS led to market fragmentation. High-frequency traders thrive on it, as it allows them to arbitrage the different markets. Decimalization and the lowering of minimum bid increments has also played a role.

Market participants also believe that there are many misunderstandings and misconceptions of the effects of high-frequency trading in the marketplace.

“High-frequency trading is like the arch villain, it’s seems like it’s easy for most people to hate it,” said Richard Bentley, industry vice president of banking and capital markets at Progress Software. “It’s clear high-frequency trading is a pariah, and like it or not, it will be target of vitriol and regulation in the next 24 months. Did high-frequency trading cause the Lehman Brothers collapse or the sovereign debt crisis in Europe? No. Is this really what the regulators should look at?”

Following last year’s “flash crash,” the markets have been under increasing regulatory scrutiny as many classes of investors shy away from the markets with volatility persisting and uncertainty continuing. Regulators have taken certain steps in an effort to rein in potential wild market swings. Single-stock circuit breakers were designed to prevent any drastic price changes by halting trading of a certain security if excessive price movements occur.

According to a report released by the Tokyo Stock Exchange in September, which refutes claims of high-frequency trading having detrimental effects on the marketplace. According to its studies, while the traditional buy-side was conducting mass sell-offs during the volatility seen in August, rapid-fire buy and sell orders from HFTs essentially had a net-neutral effect. The TSE classifies high-frequency trading as orders sent from its co-location facilities, which makes up about 30% of overall trading volume of its exchange.

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