High Frequency Trading Re-Visited - After Wall Street’s Freefall

In two previous E-TIPS® articles (August 26, 2009, Vol 8, No 5 and February 10, 2010, Vol 8, No 16), so-called high-frequency share trading (HFT) was noted as being at the heart of, respectively, civil and criminal litigation and investigations by the US Securities and Exchange Commission. Although HFT clearly had information technology implications, the topic had been reported on as being somewhat peripheral to the primary business of the stock markets. That perspective has changed after the dramatic events of early May, 2010. Following what The New York Times described as a “harrowing plunge in the stock market” on May 6, 2010 which briefly wiped out about $1 trillion in market value, the US Congress and regulators of securities and commodities trading and the market exchanges themselves have loudly proclaimed their interest in getting to the bottom of what caused the wild swings. The Chair of the Securities and Exchange Commission referred to the May 6 events as “profoundly disappointing and troubling”. At the centre of the early discussion and analysis is the role played by HFT and how much of such trading now takes place in a purely electronic environment, without the benefit of so-called “circuit-breaker” rules allowing for and requiring suspension of trading and resumption only after human intervention (as still occurs on the New York and Toronto Stock Exchanges). Conversely, some observers view the mismatch between the circuit-breaker rules of older exchanges and the younger electronic exchanges as the trigger that in fact set off the recent plunge. To fully grasp the powerful effect on the real world of bricks and mortar that HFT brings to stock trading, it is reported that in pursuit of ever-lower “latency” (the time gap between placing and executing an order), some brokerages and advisors have moved their banks of servers closer to the electronic exchanges simply to shave milliseconds from the expected latency of their transactions. For excellent analyses, see an article from the May 12, 2010 issue of The Globe and Mail, “Regulators work to stop next market dive” and an article from the May 18, 2010 issue of The New York Times, “Rules To Limit Stock Trading Amid Market Volatility”. Summary by: Richard Potter