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."
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!
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