High frequency trading or HFT is one of the tools used nowadays by trading houses in order to carry out huge amounts of trades. These are based on algorithms and computer generated softwares which track the market in terms of nanoseconds and execute trade in real time. This allows traders to minimise their cost in terms of execution which can weigh on the profits if they are maintained for too long on a trader’s books. If these traders are market makers of the security, then the problem becomes magnified as the trader has to simultaneously buy and sell the security and minimise his own position and exposure. This is why high frequency trading is favoured where the traders can use computers to handle the paper thin spreads in order to make a profit. This eliminates the need to worry about the position that the trader holds in terms of risk.
Here’s a video by Paddy Hirsch, Marketplace Senior Editor at http://marketplace.org explaining what high-frequency trading is and why some people are up in arms about it.
This seems to be coming at a price, however, where the markets are seeing issues with the software being used and there have been flash crashes caused in the past which show that even though it is a good system, it needs further improvement. The recent fall of Knight Capital Group has brought to light this issue in a new manner as now the New York Stock Exchange, the SEC and the trading community in general is taking notice. What this has shown is that it is not always a huge slip up which can be the end of it all. Sometimes something that is taken for granted, like the reliable technology and the coding mechanism, could also wreak havoc on the company.
SEC Chairman, Mary Shapiro, has said on Friday following the Knight Capital debacle that the losses seen by the company due to the technological problems are “unacceptable”. She said that even though US markets are the most robust and resilient in the world, measures still have to be taken to ensure that these issues do not take place in the future. Even if they do, there are enough controls in place which can limit the effect of these on the general investor confidence. The measures that have been put in place like circuit breakers and the ones put in place after 2010 flash crash all work to decrease the likelihood of a huge impact on the market. Shapiro said that if these weren’t in place, the impact on the markets would have eroded market confidence further. The SEC is set to carry out meetings in the coming days to address the issues that came to light due to the HFT mess that has been created. In addition, SEC has been encouraged to ensure safeguards so that the investor confidence can be sustained and increased in the markets in the future.