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Two Penn’orth Finance
High Frequency Trading
Michael Lewis’s new blockbuster -
Is it true?
Well it was certainly very quickly denied by all the people who should have denied it. But is that really going to be enough to put your mind at rest? Despite their public denials the regulators appear to be taking a closer interest than ever in high frequency trading.
A more balanced view was given by Michael Bloomberg, the former Mayor of New York City. In his opinion, the system isn’t rigged. BUT… There are always abuses.
His main observation was that ‘The spread between bid and ask, and the commissions charged to do a transaction are so dramatically smaller today’ … ‘compared to when I was in the securities business’
That’s a really important point. The same new technologies that have made high frequency trading a possibility have also improved access to the markets for the smaller investor. The reductions in the cost of dealing for an ordinary small investor are likely to far outweigh the impact of the high frequency trader.
Why? To go online today and buy a few shares is an incredibly simple process. And its all done electronically. Not so many years ago, you would have needed to phone a stockbroker. He would have phoned his order down to the exchange floor where a broker would have checked all the market makers and negotiated the best price he could. Then you would have paid cy cheque and waited while the registrar recorded your interest in the share register and issued a certificate. There’s a lot of process there to be paid for somehow.
But note what else Mr Bloomberg said. There are always abuses. Not just now but always. And do high frequency traders commit such abuses? Well maybe. But there is an important point of logic to consider here.
All cows eat grass (as my music teacher used to say) but should we conclude that anything which eats grass is a cow?
It is pretty unlikely that ALL market abusers utilise high frequency trading. But it must have attractions. Just as bank robbers like fast cars, it’s a useful tool to have access to. But can we conclude that all high frequency traders are market abusers? Certainly not! No more than we may conclude that anybody driving a fast car is a bank robber, or that anything eating grass is a cow.
High frequency trading is, in fact, nothing new. Certain market participants have always gained an advantage by reacting more quickly than their peers to new information. And somebody always will. All that has changed is that computer technology now allows those reactions to be made far more quickly than before. So quickly, in fact, that a human can not do it any more. There are some inherent risks in that. Once you set the machine up to react to a particular circumstance in a particular way, it will do so. And you will not be able to stop it. But that again must always be a feature of the fast reaction. Fastest reaction requires least thought.
It would, of course, be possible to curb high frequency trading by limiting the speed at which people can trade. But I very much doubt this would improve the overall result for the average retail investor.
There will always be abuses. If the abusers are forced to move more slowly, they will still, nevertheless, commit their abuses.
On the other hand, there are certainly some high frequency traders who are not market abusers. Some will be arbitragers, acting to improve the efficiency of the markets. They make their money by exploiting small price differences between different markets. Slow them down and they will do this less well.
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