High frequency trading has emerged over the past decade as a critical component of modern electronic financial markets. It provides liquidity, efficiency and stability to the global equities, foreign exchange, futures and other electronic marketplaces. By some accounts, two-thirds of US equity shares traded are done by high frequency systems. Yet, misconceptions abound in the popular media today concerning high frequency trading's impact and value to the broader economy.
We will discuss the value of high frequency trading, and some of the problems (both quantitative and technological) that must be solved to operate a successful high frequency system.Much of the talk focused on how Knight put its servers close to those of the NYSE so it could be first in line for trades. I failed to see the societal value. Say at the airport if someone cuts in front of the security line, they get considerable extra value but it will be cancelled out by the lost time of everyone behind him.
The company, now called Knight Capital, tried out a new algorithm last Friday and lost $440 million buying when it should have sold.
I cry no tears for Knight but such losses can have a disastrous effect on the stability financial markets. One solution is to have the government or some other agency verify code before traders can use it on the markets. But code verification is practically difficult and theoretically impossible.
I would prefer a tiny transaction tax on every trade, negligible for all but high-frequency traders. Computation has made the market nearly frictionless, time to but some friction back in.