Oct 232012

High frequency trading (HFT) has come to dominate trading in US stocks over the last decade.  Decimalization and Reg NMS has helped foster the growth of sophisticated computer programs that today buy and sell stock in a blink of an eye.   In general, HFT has contributed to increased efficiencies to the equity markets through increased liquidity, tighter spreads, and lower transaction costs.  George Sauter, the chief investment officer of Vanguard Funds recently told Traders Magazine, “I think the lion’s share of high frequency works to the benefit of the marketplace.  It provides liquidity to the marketplace.  It provides tighter spreads than we would experience otherwise.”  However, not everything is well with HFT.  The liquidity that HFT provides is fleeting and can disappear rapidly.  Some HFT can be manipulative and disrupt markets.  Since the May 6, 2010 Flash Crash, regulators, politicians, and pundits have, rightly so, massively increased their scrutiny of HFT and its impact on the market.   Some have called for an outright ban on HFT.   Last month ECB policy maker Ewald Nowotny stated, “For example with high-frequency trading there is nothing to be regulated, it is to be banned. There is no really demonstrable net advantage from this (form of trading).”   We believe an outright ban of HFT would be detrimental to the marketplace and that the best solution is smarter regulation.   Some of the rules currently being mulled that make sense to us are – a) a minimum time an order remains outstanding and b) limiting order cancellations.   Throttling HFT will bring some confidence back to the equity markets and hopefully sustained higher volumes.