Over the past few years, there has been a significant change in the process of security trading in the capital markets. “Utilizing supercomputers and complex algorithms that pick up on breaking news, company/stock/economic information and price and volume movements, many institutions now make trades in a matter of microseconds, through a practice known as high frequency trading” (McGowan, 2010, p. 1). High frequency trading is one of the major forms of algorithmic trading in the financial markets.
Obviously, HFT also has its advantages and strong points as compared to other forms of treading. HFT is characterized by speed and utilization of the most innovative technology and, consequently, by considerable reduction of the investor trading costs. Moreover, HFT strategies “appear to have had a beneficial impact on market quality metrics such as reducing bid-ask spreads and have helped reduce the volatility” (Shorter & Miller, 2014, p. 1).
Nevertheless, due to the drawbacks of high frequency trading, this form of trading causes controversy and has raised numerous public policy concerns. HFT is criticized for aggravating market stability and increasing the probability of the market’s systemic risk. Furthermore, there has been a heated discussion recently “whether it enhances or harms the quality of those markets, whether certain kinds of HFT may constitute an illegal form of front-running”, including flash orders and dark pools of liquidity (Shorter & Miller, 2014, p. 1). Another concern associated with HFT if that it “has been to the detriment of non-HFT investors and investor confidence in the securities markets” (Shorter & Miller, 2014, p. 1).
“More recently, the controversy related to high frequency trading has centered on the legality of the strategies themselves”, such as the issuance and use of flash orders (McGowan, 2010, p.15). “A flash order is a trade based on access to information for a matter of milliseconds that is not yet public. Flash orders developed due to the competition that exchanges face over the volume of shares posted on their platforms” (McGowan, 2010, p.13).
Traders benefiting from flash orders are typically exposed to the information regarding the buy and sell orders in advance of other players in the marketplace for a certain charge. Through the use of this advance notice of market conjuncture, traders get the opportunity to trade ahead of the public market. There has been much discussion over this practice recently and, as a result, the Securities and Exchange Commission has put forward a proposition to put the practice of issuing and using flash orders under an absolute ban.
References
McGowan, M. J. (2010). The Rise of Computerized High Frequency Trading: Use and Controversy. Duke Law & Technology Review, 16, 1-24.
Shorter, G., & Miller, R. S. (2014). High-Frequency Trading: Background, Concerns, and Regulatory Developments (pp. 1-42, Rep. No. R43608). Congressional Research Service.
