The Effect of High Frequency Trading Systems on Financial Markets Essay

Whilst liquidity plays a central role in the functioning of financial markets, it is volatility that can be truly detrimental. Despite almost universal agreement among academics that HFT improves prices for investors and dampens volatility in equity markets, since the 6th of May 2010 the sector has come under intense scrutiny from regulators. On a day described as the ‘Flash Crash’, the U.S stock market experienced one of the most severe price drops in its history. In the matter of five minutes, the Dow Jones Industrial Index declined by 900 points, and then recouped the balk of those losses within the next 15 minutes. This unprecedented and unexplained volatility has fired public debate ever since. In the aftermath of the US ‘Flash Crash’, regulators were quick to pin blame on HFT. Within a week the chairman of the US Securities and Exchange Commission determined there was evidence that â€Å"professional liquidity providers† pulled out of the market when shares started declining exacerbating the fall. Perhaps irrationally, policymakers without any significant evidence believe HFTs pull out of markets at signs of stress, contributing to a sudden loss of liquidity and promoting volatility (Grant, 2011).Moreover, Andrew Haldane points to the ‘flash crash’ whens he determines that the ever increasing speed of trading is amplifying volatility. In my opinion, in the aftermath of the financial crisis when regulators received so much criticism, I believe they feel they must act immediately, even if they don’t know the true problem. I consider this evident from calls for increased HFT regulation from US Senator Charles Schumer, who bases his opinion on recent news reports (Zerohedge. 2010), rather than academic research or scientific re... ...ttp://blogs.wsj.com/marketbeat/2009/12/08/volcker-praises-the-atm-blasts-finance-execs-experts/. Last accessed 04/12/11. Jones, R. (2010). Institutional Investor: Flash Crash and CyberWar. Available: http://hftsecurityrisk.com/category/flash-crash-specific/. Last accessed 04/12/11. Pagnotta, E & Philippon, T. (2010). The Welfare Effects of Financial Innovation: High Frequency Trading in Equity Markets. Available: https://editorialexpress.com/cgi-bin/conference/download.cgi?db_name=SED2011&paper_id=1246. Last accessed 04/12/11. Mackenzie, M & Demos, T. (2011). Fears linger of new ‘flash crash’. Available: http://www.ft.com/cms/s/0/d18f3d28-7735-11e0-aed6-00144feabdc0.html#axzz1fPJAVyJm. Last accessed 04/12/11. Geithner, T. (2007). Liquidity and Financial Markets. Available: http://www.newyorkfed.org/newsevents/speeches/2007/gei070228.html. Last accessed 05/12/11.