High Frequency Trading: Too difficult to rein in?

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The last few years have seen trading move from minds to machines, from brains to bytes and from calling out orders to typing it in. This would mean that human interaction has been minimised with trading being carried out between terminals and computers rather than people. The pit trading style of yesteryear where hand signs and eye contact was enough to complete a transaction has been replaced. With the advent of technology, the possibilities have magnified. Now international trading takes place within seconds of each other and it is possible with traders and dealers to take a position and hedge over it or even sell it off in another market within seconds while minimising loss and risk exposure. The calculating power of the behemoths of 1980s has been taken over by the palm tops of traders and brokers being used nowadays. Is that good or bad? Science has always been a curse and a blessing…

The fact that the same tools are used to develop medical cures and biological weapons shows that the power to build or destroy resides within. The same way, technology in trading has led to faster, better and more efficient trades in recent times. However, the glitches and problems associated with trading and especially High Frequency Trading has exposed brokerage houses to additional risk that never existed before. The example of Knight Capital in recent history clearly shows that even though everything is set up a way that it is functional and operational, still, technology glitches and conflicts lead to problems that can have disastrous consequences. The fact that Knight Capital had to look for additional capital to cover its losses shows that HFT and its problems should be controlled before there is an even worse disaster.

Regulators still seem to be moving slow on this issue though. The issue has been raised in the past as well where SEC has been asked to take serious steps to curb this activity or to at least limit it to an extent it can be controlled under. Slow or lack of any action shows that SEC still does not appreciate the magnitude of the crisis and that it should do more. A meeting is to be held Tuesday on how to handle software glitches and of all the participants, SEC seems to be the slowest organisation as other countries are moving to introduce safeguards and protective measures. One of the recommendations being considered is a kill switch to shut down trading of a computer program in order to limit the losses and exposures of any situation. If this was possible in the Knight Capital situation, it would have saved many of the losses that were incurred. This is also beneficial for the investors as they would be protected in the future against any adverse event. The Flash Crash that saw the Dow Jones lose 700 points in seconds would also have had been prevented.

The lack of protective measures and any substantial action is not only hurting the market participants financially but it also loses investor confidence and any future prospect investors as it leads to higher uncertainty. People are not sure what they should expect from the market and considering the fact that it is all interconnected, there are effects of HFT on regular investors who are investing using their pensions and 401-Ks. SEC has to take a decision now by balancing the liquidity provided by the HFT traders against the risk and uncertainty they introduce so that there is some sort of protection offered to the regular investors. It is not a revolutionary move but one of compliance with other participants who are already taking steps to do so.

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