High‐Frequency Trading and the New Stock Market: Sense And Nonsense

Abstract

The stock market has been transformed during the last 25 years. Human suppliers of liquidity like the NASDAQ dealers and NYSE specialists have been replaced by algorithmic market making; stocks that once traded on a single venue now trade across twelve exchanges and a multitude of alternative trading systems. New venues like dark pools, and new participants like high‐frequency traders, have emerged to take on prominent roles. This new market has had more than its share of controversy and regulatory scrutiny, particularly in the wake of Michael Lewis’s bestseller Flash Boys. In this article, the authors analyze five of the most controversial new market practices, including various high‐frequency trading strategies and dark pool activities. They set out a simple conceptual framework based on adverse selection and agency problems, and apply that framework to assess the welfare effects of each of the five practices. While much that is criticized is indeed objectionable, other controversial practices are much more complex than popularly imagined and may in fact be socially desirable. They conclude by evaluating a range of potential reforms to equity market structure.

The Disruptive Implications of Fintech-Policy Themes for Financial Regulators

“…The slower trader who transacted with the HFT in a layered market has incurred an adverse selection cost. 227 HFTs that appear to supply constant liquidity are also themselves liquidity takers. 228 HFT has the potential of splitting up large institutional orders to obtain best prices across different markets, but also has the potential of sniffing out large institutional orders in dark pools and executing against them at less than sub-optimal prices for the institutional investor.…”

“…228 HFT has the potential of splitting up large institutional orders to obtain best prices across different markets, but also has the potential of sniffing out large institutional orders in dark pools and executing against them at less than sub-optimal prices for the institutional investor. 229 Although some HFT practices are arguably competitive innovations not involving market abuse, commentators raise questions over (a) the fairness or otherwise of engaging in such innovative advantage; (b) the potential for HFT to sponsor market abuse and (c) how HFT may undermine regulatory objectives such as financial and market stability.…”

Experimental Comparison of HFT Pair Trading Strategies using Microsecond and Nanosecond Future Commodity Contracts Data

“…HFT refers to the increasingly widespread practice of using algorithmic programmes to execute trades, based on split-second changes in market conditions. High frequency trading platforms have replaced the traditional auction-like floor where traders compete on price (Fox et al, 2015). The main focus of HFT is to beat the time.…”

“…Nowadays, financial markets are fully automated, consisting of algorithmic trading, thus, they are largely dominated by high frequency trading (Fox et al, 2015). HFT refers to the increasingly widespread practice of using algorithmic programmes to execute trades, based on split-second changes in market conditions.…”

Complexity and Economic Policy: A Paradigm Shift or a Change in Perspective? A Review Essay on David Colander and Roland Kupers's Complexity and the Art of Public Policy

“…Witness the recent prosecution of an individual in London, who it is claimed was at least partially responsible for the "flash crash" in May 2010. For a discussion of the various strategies that have emerged in financial-markets trading and their consequences, see,Fox, Glosten, and Rauterberg (2015).…”