Recently, there have been moves by regulators, particularly the SEC, to place restrictions on the growing practice of “high frequency trading”. This is the process where Wall Street firms use sophisticated algorithms and powerful computers to generate high volumes of orders and send them into electronic markets at high speed.
Why? Because high frequency trading is increasingly being viewed by both the public and the regulators alike as a potentially harmful activity that could adversely impact the integrity of the markets.
For this reason, the SEC have issued a public consultation document, asking some wide ranging questions about whether the automated exchanges are being used in a way that is fair and equitable to all investors, regardless of their size or how they access the electronic markets.
According to the High Frequency Trading Review, they key question is whether private investors and institutional fund managers who take out longer-term positions are disadvantaged by the strategies used by the high-frequency traders, i.e. firing thousands and thousand of so-called “orders” to the exchanges’ matching engines, the vast majority of which are subsequently cancelled with no intention of actually being executed.
The concerns are very real, but equally there are concerns in certain quarters that what the SEC is doing is creating battle lines between short-term and long-term investors.
There has always been, and there will always be a precarious balance between short-term traders and long-term investors. That balance is what creates markets after all.
But the SEC has stated quite categorically that if an imbalance exists, the regulator’s duty is to uphold the interests of the long-term investors ahed of the professional short-term traders.
The content of the consultation document itself is highly focused around high frequency trading and the strategies behind the practice, placing a particular emphasis on “order anticipation”. This is where most of the controversy seems to lie. Does order anticipation help the markets, making them more efficient by quickly moving prices in the direction they were going to go anyway, or does it hinder the markets by allowing high frequency traders to scalp prices in a sophisticated form of “front-running”.
The jury is still out. But one thing is guaranteed. The controversy around high frequency trading is not going to go away any time soon.