High frequency trading improves market fairness
Monday, 9 December 2013 11:55am

High frequency traders (HFTs) improve market fairness by reducing end-of-day price dislocation, new research from the Capital Markets Cooperative Research Centre (CMCRC) has found.

CMCRC examined data from 22 exchanges from around the world, from 2003-2011 and found that the presence of HFT decreases the probability of end-of-day (EOD) dislocation by 21%.

The report also found that HFT was associated with a decrease in the total trading value surrounding each suspected dislocation, by at least 42% relative to the average size of the total trading value, suggesting that the mere presence of HFT participants in a marketplace may discourage EOD dislocation.

"EOD prices are often used to determine the expiration value of directors' options, the price of seasoned equity issues, evaluate broker performance, calculate net asset values of mutual funds, and compute stock indices," CMCRC chief executive and co-authors of the report Professor Mike Aitken said.

"So on the one hand there's clear incentive to manipulate the closing price by ramping end-of-day trading to push the closing price to an artificial level. However, EOD dislocation could also simply reflect price pressure brought on by the fact that the market is about to close for 18 hours. Either way, EOD dislocation of prices is not a good look for markets."

The data showed that in the presence of HFT, EOD price dislocation was also less pronounced on specific dates when EOD price dislocation was most likely to experience manipulation, including dates when options expire and the end of month/quarter calendar dates.

According to CMCRC, HFT accounts for around 50%-70% of equity trades in the US, 40% in Canada, and 35% in London.

Electronic, algorithm-based trading has been in use since the 1970s but concerns have escalated in recent years as improvements in technology have allowed trades to happen ever-faster rates speeds.

Opponents of the practice say that it gives traders an unfair advantage, manipulates markets and causes unexplained crashes.

While an Australian Securities and Investments Commission (ASIC) taskforce into HFT said in March that fears are unfounded, the regulator has recently introduced new disclosure rules in a bid to improve transparency.

Professor Aitken said that policy mechanisms, including trading rules, surveillance and enforcement, appeared to have had less of an effect in mitigating EOD price dislocation than HFT, suggesting that the market may indeed be capable of disciplining itself.

"There is an established negative relationship between liquidity and EOD prices (i.e. the higher the liquidity the harder it is to manipulate or the less prices will move) and that HFT by either providing additional liquidity at these points (or because market participants know that HFT are present in a marketplace) appears to reduce EOD dislocation, whether it is caused by fair means or foul."

1 comment on this article
Christopher J Tubby from T 1 Con Ltd wrote:
It is the responsibility of Market Makers, whether they are HFTs or other, to prevent price dislocation. However, Exchanges seem to favour those (HFTs) with the shortest investment horizon at the expense of those with the longest, purely because of the volume they produce. Where were HFTs before electronic trading was introduced, and the markets were probably better priced then!
9 December 2013 10:57pm
Follow the industry experts.
Christopher Page
Christopher Page
Managing Director

Medcraft's appalling speech
I am surprised. More than that, I am astonished, shocked. Last week I was left speechless by the address that the Australian Securities more
Benjamin Ong
Benjamin Ong
Chief Economist

Reflation, rotation and the taper
'Tis being my final type (drivel, to some gentle readers) for the year, we'll take a look back at the 2013 that was to seek the lessons ... read more
Alex Dunnin
Alex Dunnin
Director of Research & Editorial Services

Women-led companies better for investors
The Australian government end last year released its first Gender Equality Scorecard and while the results are discouraging, a separate ... read more
News Search   
VideoBrought to you by
The global and Australian economic outlook
The anchor man of the panel, Saul provides great insights on the domestic economy. And bravely makes the forecast that the Reserve Bank will not cut interest rates this year and that the next move is up ... Watch video
The two-speed economy in reverse
James provides a local perspective and explains to the audience why the mining investment boom is an aberration and it is now a 'return to the old normal'. To view James Bond's slides please click ... Watch video
The major economies in 2015
Is the European economy dead in the water? Is faith on Abenomics waning? Why should investors be more optimistic about the US economy this year? Chris Probyn, the Boston-based chief economist of State ... Watch video
Great unwindings
Bob believes plunging oil prices may extend the stockmarket rally by a year or two and discusses why investors could expect a volatile few months. Overall, he believes we are entering an era of low returns ... Watch video
Market Thinking - A different way of looking at economies?
First, a confession. Mark may have started his career as an economist but he joins this year's panel not as a chief economist but as the head AXA Framlington Asia. This is to the benefit of the audience ... Watch video
Get it
FREE to your inbox, get the Financial Standard Daily Email.
Get the Free
iPad app
Download the Financial Standard iPad app for FREE
Adviser Big Day Out Investment Manager Roadshow-Perth
Adviser Big Day Out Investment Manager Roadshow-Adelaide
Adviser Big Day Out Investment Manager Roadshow-Melbourne
Adviser Big Day Out Investment Manager Roadshow-Brisbane
Adviser Big Day Out Investment Manager Roadshow-Sydney

$245 (inc GST) for 1 year
Copyright © 1992-2015 Rainmaker Group
All material on this site is subject to copyright. All rights reserved. No part of this material may be reproduced, translated, transmitted, framed or stored in a retrieval system for public or private use without the written permission of the publisher.
Link to something 3rVZYPYb