High-Frequency Trading a Hazard or Boon to the Market?

August 22, 2011

Is “black box” trading more of a threat to the markets than short selling? That’s the view of former City minister and British investment industry veteran Lord Myners.

“High-frequency trading appears so detached from the true function of capital markets, but is potentially fraught with hazard. It definitely deserves more attention than either the Financial Services Authority (FSA) or the Treasury has given it,” said Myners in a recent interview, reported in the Guardian.

High-frequency trading, as you may know, is a hedge fund strategy driven by complex computer algorithms rather than more traditional stock-picking methods. Such programs have the ability to digest huge volumes of market data in a fraction of a second. The computer programs pounce on fleeting trading patterns, rather than analyze underlying company fundamentals, and have the ability to execute thousands of trades in a heartbeat.

Some hedge funds have turned over the bulk of their trading decisions to such algorithmic approaches. In fact, in 2009, high-frequency trading was estimated to account for 70% of all share transactions on the New York Stock Exchange.

Myners now believes that high-frequency trading has triggered the record levels of market volatility that we’ve seen in recent weeks, and threatens the stability of markets.

On the flip side, the volatility we have seen recently has led to some record profits for high-frequency traders, reports the Wall Street Journal. Some high-frequency traders have even cut short their August vacations to return to their computer screens.

“Any pop in volatility is instant, and it goes away as fast as it appeared,” said Rishi Narang, head of Telesis Capital LLC and founder of a quantitative trading firm. “The volatility means you can do more in a short period of time.”

High-frequency traders have roughly tripled their stock trades this month, estimates Tabb Group, a markets-research firm in New York. That has boosted their share of overall U.S. stock trading volume to about 65%, up from about 53% during the months before the August turmoil, according to the research firm.

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