Most Popular
1. Banking Crisis is Stocks Bull Market Buying Opportunity - Nadeem_Walayat
2.The Crypto Signal for the Precious Metals Market - P_Radomski_CFA
3. One Possible Outcome to a New World Order - Raymond_Matison
4.Nvidia Blow Off Top - Flying High like the Phoenix too Close to the Sun - Nadeem_Walayat
5. Apple AAPL Stock Trend and Earnings Analysis - Nadeem_Walayat
6.AI, Stocks, and Gold Stocks – Connected After All - P_Radomski_CFA
7.Stock Market CHEAT SHEET - - Nadeem_Walayat
8.US Debt Ceiling Crisis Smoke and Mirrors Circus - Nadeem_Walayat
9.Silver Price May Explode - Avi_Gilburt
10.More US Banks Could Collapse -- A Lot More- EWI
Last 7 days
Stock Market Volatility (VIX) - 25th Mar 24
Stock Market Investor Sentiment - 25th Mar 24
The Federal Reserve Didn't Do Anything But It Had Plenty to Say - 25th Mar 24
Stock Market Breadth - 24th Mar 24
Stock Market Margin Debt Indicator - 24th Mar 24
It’s Easy to Scream Stocks Bubble! - 24th Mar 24
Stocks: What to Make of All This Insider Selling- 24th Mar 24
Money Supply Continues To Fall, Economy Worsens – Investors Don’t Care - 24th Mar 24
Get an Edge in the Crypto Market with Order Flow - 24th Mar 24
US Presidential Election Cycle and Recessions - 18th Mar 24
US Recession Already Happened in 2022! - 18th Mar 24
AI can now remember everything you say - 18th Mar 24
Bitcoin Crypto Mania 2024 - MicroStrategy MSTR Blow off Top! - 14th Mar 24
Bitcoin Gravy Train Trend Forecast 2024 - 11th Mar 24
Gold and the Long-Term Inflation Cycle - 11th Mar 24
Fed’s Next Intertest Rate Move might not align with popular consensus - 11th Mar 24
Two Reasons The Fed Manipulates Interest Rates - 11th Mar 24
US Dollar Trend 2024 - 9th Mar 2024
The Bond Trade and Interest Rates - 9th Mar 2024
Investors Don’t Believe the Gold Rally, Still Prefer General Stocks - 9th Mar 2024
Paper Gold Vs. Real Gold: It's Important to Know the Difference - 9th Mar 2024
Stocks: What This "Record Extreme" Indicator May Be Signaling - 9th Mar 2024
My 3 Favorite Trade Setups - Elliott Wave Course - 9th Mar 2024
Bitcoin Crypto Bubble Mania! - 4th Mar 2024
US Interest Rates - When WIll the Fed Pivot - 1st Mar 2024
S&P Stock Market Real Earnings Yield - 29th Feb 2024
US Unemployment is a Fake Statistic - 29th Feb 2024
U.S. financial market’s “Weimar phase” impact to your fiat and digital assets - 29th Feb 2024
What a Breakdown in Silver Mining Stocks! What an Opportunity! - 29th Feb 2024
Why AI will Soon become SA - Synthetic Intelligence - The Machine Learning Megatrend - 29th Feb 2024
Keep Calm and Carry on Buying Quantum AI Tech Stocks - 19th Feb 24

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

High-Frequency Trading Could Cause Another Flash Stock Market Crash

Stock-Markets / Financial Crash Feb 01, 2012 - 08:01 AM GMT

By: Money_Morning

Stock-Markets

Best Financial Markets Analysis ArticleDavid Zeiler writes: The threat of another flash crash caused by high-frequency trading is as great as ever.

And the next flash crash could be much worse than the one that shocked investors in May 2010.

Although the Securities and Exchange Commission (SEC) has taken some steps to prevent another flash crash caused by high-frequency trading (HFT), some experts question whether the additional disclosure and "circuit-breakers" designed to prevent big, sudden price moves will make a difference.


"Those things won't prevent another flash crash - they can't," said Money Morning Capital Waves Strategist Shah Gilani. "All they will do is soften the move."

The real issue, Gilani said, lies with the computers that execute the trades - thousands of them in milliseconds.

HFT has changed the nature of the stock market since these trades now account for between 60% and 70% of the transactions on the U.S. stock exchanges.

"You can't stop a flash crash unless you stop the computers from doing what they're programmed to do. And that's not being addressed," Gilani said. "The SEC is looking at keeping the ship from sinking, not stopping it from hitting icebergs."

HFT's heavy volume and high speed made it the prime suspect in the flash crash of 2010, when the Dow Jones Industrial Average plunged more than 600 points in five minutes, before recovering almost as quickly.

Mini Flash Crashes
Since then, the frequent occurrence of mini flash crashes - when a single stock or exchange-traded fund experiences a steep and rapid drop in price that quickly reverses - have served as nagging reminders of the vulnerability of the system to such events.

"It's like seeing cracks in a dam," James J. Angel, professor at the McDonough School of Business atGeorgetown University told The New York Times. "One day, I don't know when, there will be another earthquake."

Studies of HFT and the 2010 flash crash have supported the idea that the markets are still vulnerable.

A study commissioned by Barron's applied the new SEC circuit-breaker rules to trading data from the 2008-2010 period with troubling results.

Had the current trading limits been in place during the 2010 flash crash, only 14% of stocks in the Russell 1000 would have been affected.

Although not proof the circuit-breaker rules would fail, the study did show the need for more back testing of the new rules.

"While I understand the pressure to "do something' in the wake of the flash crash, it is disconcerting that no one has done this sort of back testing in advance of policy decisions," Casey King told Barron's. King, director of the Yale School of Public Health's Center for Analytical Sciences and a former Salomon Brothers employee, conducted the study.

A second study, conducted by the U.K. Department for Business, Innovation, and Skills, concluded that the computerized complexity that made the flash crash possible in 2010 make it just as likely to happen again.

And the next time could be worse.

"The true nightmare scenario would have been if the crash's 600-point down-spike, the trillion-dollar write-off, had occurred immediately before the market close," the U.K study notes. "The only reason that this sequence of events was not triggered was down to mere lucky timing the world's financial system dodged a bullet."

High-Frequency Trading Vampires
Adding to the concern is that only 2% of the 20,000 brokerages account for all that high-frequency trading, and they bet big money doing it. In 2008 alone, Citadel Investment made $1 billion in profits from its HFT operations.

HFT critics claim these firms simply suck money out of the market.

Many HFT transactions are made solely to "sniff out" the market for demand and are withdrawn as quickly as they are initiated. That's what gives many HFT firms their lucrative edge.

In fact, as many as 95% of HFT trades are cancelled, undermining the argument that HFT adds liquidity to the market.

Experts say the SEC needs to go much further to have any hope of eliminating the threats that high-frequency trading poses.

Gilani suggested the SEC implement filters in the HFT traffic to the exchanges that would slow down opening transactions but not closing transactions. That would help "close the loop that remains open in fast-moving markets when new positions are entered, sometimes to knock down prices to facilitate the vacuum that results in bids evaporating and prices collapsing."

Money Morning Global Investing Strategist Martin Hutchinson offered two other solutions.

First, the SEC could introduce a rule that all orders must be exposed for a full second. That will reduce the volume of high-frequency trading, but still wouldn't truly protect non-computerized outsiders.

The second idea would be to introduce a small "Tobin tax" on all share transactions. It could be tiny; maybe 0.01%. (The SEC would also need to ban "exchange rebates" to traders).

"Such a tax would make the worst HFT types unprofitable, without imposing significant costs on retail investors," Hutchinson said. "It's about time the governmentimposed some taxes to stop the worst of these scams and recover the public some of its money."

But until the SEC implements stricter measures, high-frequency trading will keep the markets susceptible to trading excesses as well as another flash crash.

"We had a lot of change, we had a lot of money, we had no transparency, and it almost destroyed the financial system of the world," former Sen. Ted Kaufman, D-DE, an outspoken critic of HFT, told the Baltimore Sun. "I cannot stress enough how worried I am, how concerned I am about what's happening to our markets."

Source http://moneymorning.com/2012/02/01/high-frequency-trading-could-cause-another-flash-crash/

Money Morning/The Money Map Report

©2012 Monument Street Publishing. All Rights Reserved. Protected by copyright laws of the United States and international treaties. Any reproduction, copying, or redistribution (electronic or otherwise, including on the world wide web), of content from this website, in whole or in part, is strictly prohibited without the express written permission of Monument Street Publishing. 105 West Monument Street, Baltimore MD 21201, Email: customerservice@moneymorning.com

Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

Money Morning Archive



© 2005-2022 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

sbulltrader
01 Feb 12, 15:39
Something doesn't make sense

The comment "In fact, as many as 95% of HFT trades are cancelled, undermining the argument that HFT adds liquidity to the market." makes no sense.

First of all, 95% of ORDERS are cancelled, not trades. Secondly, the cancelled orders are almost always replaced by another order, so the actual liquidity provided by high frequency stays the same, just at different prices.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in