High-speed computers put stock markets at risk

An estimated 60 percent or more of trading on world stock exchanges is done not by human beings, but by computers executing, in fractions of a second, orders based on complex algorithms that human traders do not fully understand.

There is a name for this: High Frequency Trading.   Andrew Haldane, executive director for financial stability at the Bank of England, said in a speech quoted by New Scientist magazine, that HFT threatens the stability of world financial markets.

High frequency trading algorithms can execute an order in just a few hundred microseconds, rapidly trading shares back and forth in order to quickly eke out profits from minor differences on the various exchanges.  These trades are so fast that the physical location of the computers executing them becomes vital – even being a few hundred kilometers away from the exchange could mean missing out. 

It’s commerce far removed from any ordinary experience, as Haldane illustrated with an every day example: “If supermarkets ran HFT programs, the average household could complete its shopping for a lifetime in under a second.”

Now it seems this lightning-fast trading could come at a cost.  Haldane blamed HFT for causing the “Flash Crash” which occurred on US markets last year, with the Dow Jones losing $1 trillion in just half an hour.  The event was marked by trading oddities such as management consulting firm Accenture shares falling from $40 to $0.01, while auction house Sotheby’s rose from $34 to $99,999.99 – the lowest and highest values permitted by HFT algorithms.

via One Per Cent.

The computers as such aren’t the problem.  The problem is profits per share in high-frequency trading are tiny, so that traders need to buy and sell huge volumes in order to make it worthwhile, and they need to act with lightning speed to get ahead of other traders.

High frequency trading has become so big a business that it overshadows what the financial markets are supposed to do, which is to allocate capital to companies with the greatest potential to produce good products and services.   Instead of looking for well-managed companies or entrepreneurs with good ideas, the high frequency traders devote all their ingenuity to beating the market—a self-defeating purpose, when they are the market.

One way to slow down high frequency trading is a nominal tax on stock market transactions — say, 1/10th of 1 percent or even 1/100th of 1 percent.  This would be hardly noticeable to the average investor, but would create a disincentive to trade huge amounts of shares for miniscule per-share profits at frequent intervals.  The European Union is considering a transactions tax, but Treasury Secretary Timothy Geithner opposes one in the United States.

Click on High speed trading algorithms place markets at risk for the full article on the New Scientist web log.

Click on Computer Algorithms Take Control of Wall Street for an article by Felix Salmon and Jon Stokes in Wired magazine.  They said that, by some estimates, computer-driven high-frequency trading is 70 percent of total Wall Street trade volume.

Click on High Frequency Stock Trading Catches Regulators’ Eyes for a New York Times article on proposals for regulation.

Click on EU Proposes Financial-Transactions Tax to Start in 2014 for a Business Week article about a proposed tax on securities trades.

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One Response to “High-speed computers put stock markets at risk”

  1. Roberto Cisternino Says:

    You are right the error is not the computer, but I add also that in general the issue is the transaction speed because it is increasing continuously and it is far from human capabilities. The stock game is out of control today… no more compatible with the human race, this is the problem. The stock should be slow as the human decision for having the free economy rule working these days.
    This is no more a free economy… there is no more the balanced analogic human influence in the economy. Global economy is deviated by computers and far from humans.
    It is like asking a man to eat more food than possible, or like having 400 Km/h cars around. I make this sample to evidence that the stock is incompatible with the human race. So I do no see any solution until we keep the game close to our nature and of course close to the original mission of the stock.

    Roberto Cisternino

    Like

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