The number of stories, articles and academic papers on high frequency trading has reached a fever pitch lately. It’s the good, bad and the ugly and like any highly publicized news story the media attention is on the bad and ugly and the positive is often downplayed. We can thank the May 6th Flash Crash for putting HFT in the frenzied spotlight.
The last few articles I’ve read have been across a broad spectrum, from your layman’s description (and judging by the commentary, it’s readership would not be my choice for a jury in a HFT legal trial) to complex mathematical proof of it’s positive influence. In the end, I hope all the media attention will provide clarity to the HFT subject, and separate fact from noise allowing those yielding a big stick to determine reality from myth and what’s legitimate vs. predatory as regulation looms closer.
Those accountable for recommending and instituting regulations have a tall order to decipher the glut of information on this topic. Much of what is written is making bold statements pointing the finger solely at HFT firms for the events of May 6th, “… many high frequency traders pulled out during the freefall, leaving a dearth of liquidity exacerbating market volatility …“. The SEC is considering regulation requiring these de facto market maker HFT firms to hold liquidity obligations. Anybody with resting Orders in the book is making a market, but the intent is to indicate a specific threshold of investment. This last aspect will be the challenging part, I just have a suspicion that loopholes abound.
The goal of most businesses is to turn a profit. While safeguards from catastrophic loss will vary from industry to industry, for the employees and investors it’s comforting to believe that such measures are in place. If faced with the unfortunate choice of preventing such a ruinous loss and the long-term ramifications it poses, and paying penalties because of a failure to met regulatory obligations, my bet most firms will choose wisely for the long-term health of their firm regardless of what penalties they may face.
The SEC indeed faces a tough road ahead. They are under the pressure to enact regulation quickly. Unfortunately, appeasement to public sentiment looms overhead, enacting regulations that are reasonable and are not draconian will prevent wholesale defection of HFT firms from equities to FX, Fixed Income or the derivative markets. Certainly some of the blame can be directed at HFT firms, those practicing quote stuffing creating false liquidity has gamed far too many players. But Jonathan Brogaard’s academic paper provides a litany of mathematical proof points that indicate HFT’s provide the best quotes 45% of the time and tend to make more money in volatile times.
In any failure situation there are multiple guilty parties, the blame game has many fingers. Interestingly, Steve Wunsch, points a finger straight at the SEC for setting in motion the RegNMS based market structure and it’s fragmented nature we live in today. Making sense of that is challenging.
The last thing anyone wants is regulations so complex that legal interpretation creates loopholes you could drive a truck through (think US tax code system). We can only hope the SEC will be able to separate the wheat from the chaff and institute reasonable and fair regulations. We shall see.
Once again thanks for reading.
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