High Frequency Trading and Risk Controls
Many changes have hit the US equities markets over the last few years. One of the key drivers behind those changes is the continued march of technology, to an extent where many now consider the markets to be dominated by machines, rather than humans. This is not fantasy. Orders generated by high frequency trading (HFT) systems now account for more than 70% of total US equity market volume, according to the High Frequency Trading Review.
Of course, along with new paradigms such as this come new risks.
There have already been instances of HFT systems going wrong and erroneously sending hundreds of thousands of orders into the market, thereby bringing trading to a near halt. Witness what happened with Credit Suisse on the New York Stock Exchange in 2007, a case that came to light recently when the bank was hit with heavy fines for not putting the necessary controls around their systems.
The problem is that as the machines get faster and are able to spit out more and more orders in shorter and shorter timeframes, the potential for this kind of thing happening again, but on a larger scale, is only increasing. When you consider that some Wall Street firms have HFT systems that can not only generate an order, send it to the exchange, have the order executed an reported back in less than one thousandth of a second, but also submit thousands of those orders at the same time, the consequences of a rogue, unfiltered algorithm hitting the market don’t bear thinking about.
It is for this reason that the regulators, in particular the SEC (Securities and Exchange Commission) are now looking at a series of proposals that will curb the activities of some of the more risky high frequency trading activities. One of these proposals is to outlaw “naked access”, which is where an exchange member firm opens up its market access gateway to clients, without any filters in place. The reason firms do this is because allowing orders to pass through without any pre-trade filtering or limit checking ensures the lowest possible latency, and low latency is the name of the game when it comes to high frequency trading. Understandably, neither the exchanges nor the regulators are particularly happy with these arrangements because of the risk involved.
Some players are worried that these proposed controls could end high frequency trading altogether, but that is unlikely, particularly if the same rules are applied to all exchange member firms.
No related posts.
Related posts brought to you by Yet Another Related Posts Plugin.