After weeks of volatility in the UK stock markets the former City minister, Lord Myners, has called for the Financial Services Authority and the Treasury to investigate the use of so called ‘black box trading’.
Several countries (Spain, Italy, Belgium, Turkey, Greece and France) recently slapped bans on certain types of short selling in an attempt to reduce volatility. But Lord Myners believes that the recent relatively wild swings in the markets were more due to the use of computerised high frequency trading (HFT) than short selling.
With HFT, investment strategy is decided on by a computer algorithm rather than by a human being picking stocks in the traditional manner. As computers can process vast amounts of data in nanoseconds and so identify trends more quickly and efficiently there is the inevitable move towards letting the computers take over.
But the algorithms are generally programmed to identify trading patterns, not the true underlying strength of the traded companies. So many experts argue that these programmes create volatility. And volatility is the environment in which these automated beasts make their profits.
As would be expected HFT traffic has increased over the years and, even in 2009 it has been estimated that 70% of New York share deals were based on HFT. The FT now says that “According to Market Data Peaks, a U.S. company which measures trading traffic, messages were being sent at the rate of 4.7m per second on Monday, compared with 1.5m per second in September last year.”
The Telegraph quotes Lord Myners as saying ‘HFT appears so detached from the true function of capital markets, but is potentially fraught with hazard. It definitely deserves more attention that either the FSA or the Treasury has given it.’ A review of computer trading has already been set up under the Treasury minister Mark Hoban, which is due to report in 2012.
Some supporters of HFT say that its use provides liquidity to the market, but a recent study by Eric Hunsader, a real time trading and market data software expert, shows that an HFT algorithm, that he calls the Disruptor, actually leaked liquidity out of the emini market.
Then there are the ‘headfake’ trades, where orders are placed and almost immediately cancelled.
Whatever the effects on the markets, these HFT programmes obviously make a shed load of money for the programmers and users. Otherwise they wouldn’t use them.
And if most trades are now being conducted by them then surely the small trader or investor is at a severe disadvantage?
Then there is ‘market sentiment’. Computers are not sentimental. Computers will look at immediate trading patterns, how can they look at the changing political situation in a country and assess its impact, or what the change of the management structure of a company will do to its profitability?
We’ve seen what happens when we lose control of the financial system. Are we really going to let it continue to be dominated more and more by the fast buck hungry HFT operators? And if we do won’t all the money just end up in the hands of the owner of the biggest fastest super computer of them all?