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Editor’s blog – High-frequency trading, the rise of the machines

By Dean Carroll

In the 17th century, it is said that the Rothschilds were able to balance stock markets in their favour by flying carrier pigeons to relay information before their peers. Today’s equivalent is high-frequency trading. It is hard to believe but more stock market deals are now carried out by computers than humans, in a number of areas.

We know that HFT, guided by complicated algorithms, takes place in a millisecond or even a microsecond but the speed and volume of deals allows firms to maximise profits. There is no long-term strategy, no major leverage and only light-touch regulation. In Europe, HFT is estimated to be responsible for around 40 per cent of equity trades. In the United States, the figure is closer to 60 per cent.

What’s not to like? I hear you say. Well, HFT creates extreme market volatility and has even resulted in a ‘flash crash’. On May 6, 2010, US index the Dow Jones plunged 1,000 points – or 9 per cent of its total – only to recover those losses within minutes. This shock was a direct result of HFT. And the sequence of events was triggered by a single sale of $4.1bn in futures contracts by a mutual, in an aggressive attempt to hedge its investment position. This was quickly magnified by HFTs, creating a snowball effect.

Not only that, the limited uses for such a trading device are to pump up pension funds or to create greater wealth for the super-rich. All this without truly investing in a productive asset – a company that might make a difference to wider society. Any integrity markets might have once had now lies in tatters.

Although there is a view that as HFT becomes more commonplace, it will lose its profitability as everybody will be gaming the system at the same time and level; meaning no one firm can gain competitive advantage over another. However, if the algorithms advance to become comparable with the computing power of the human brain then it really will amount to the ‘rise of the machines’.

Nobel Prize winning economist Michael Spence has already called for HFT to be banned. And Joseph M. Mecane of NYSE Euronext, which operates the New York Stock Exchange, said: “It’s become a technological arms race, and what separates winners and losers is how fast they can move.”

At this precise moment, the world of HFT is analogous to a frontier town. Only this time, it is not humans displaying Wild West-style behaviour but the machines we have created. The flash crash of 2010 was a wake-up call. However, it seems the regulators are still asleep and we all know where that leads – circa the 2008 global economic crisis we are still coming to terms with today. Perhaps, carrier pigeons were not such a bad idea after all.

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