Tuesday, June 01, 2010

High Frequency Trading

Tim Bass upsets a few more people with his provocative posts arguing that authorities should Strongly Regulate High Frequency Trading (May 2010) and claiming that High Frequency Trading Destroys Market Integrity (May 2010).

Reading through the comments, it is necessary to separate three separate questions.
  1. the potential value of certain classes of technology (notably CEP) to those using these technologies
  2. the system-wide effects of using these technologies
  3. the ethical consequences of these system-wide effects.

Taking the third question first, what does "market integrity" actually mean? The notion of "equal playing field" implies that certain forms of advantage are eliminated. The notion of "playing field" implies that certain forms of advantage may still exist - otherwise there would be no point playing.

For example, some sports are so expensive that only affluent people or well-funded organizations can compete. (Think F1 motor racing, yacht racing, anything with horses.) And in any sport, wealth can get you access to superior training facilities - tennis players with money can fly to Florida when it's raining at home. But there are still rules that prevent certain forms of unfair practices, or certain types of equipment, and there is still a certain amount of talent involved, so that the outcome cannot be simply predicted from the amount invested.

High frequency trading may indeed be directly available to some players and not others. Lots of people clearly believe this provides a genuine advantage, else they wouldn't invest in it. The effects of this are asymmetric - those possessing the technology may experience a detectable advantage, even if those lacking the technology may not experience a detectable disadvantage. Taking profits out of the system, without harming any individual investor, is a "victimless crime"; according to extreme libertarians, a "victimless crime" isn't a crime at all, and is therefore not an appropriate subject for regulation.

However, most people accept the need for some market regulation, not just to protect individual investors, but also to protect the integrity of the market. If only we knew what that actually meant in this case.

See Tim Harford, Algorithm and Blues (Financial Times Feb 2013)

Updated 3 Feb 2013

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