High-Frequency Trading

Overview

HFT is a type of algorithmic trading characterized by high speeds, high turnover rates, and high order-to-trade ratios that leverages high-frequency financial data and electronic trading tools. Effective regulation of this activity is necessary to ensure that traders who trade on the basis of momentary price disparities and trends do not engage in market manipulation or undermine the ability of other investors to buy and sell securities.

A combination of rapid advances in computing power, improvements in trading algorithms, massive investments in technology, and regulatory leeway has made HFT pervasive in equity markets.

A number of high-profile failures have been linked to HFTs in recent years. HFT firms received significant criticism for their role in fleeing the market during the May 2010 “Flash Crash.” A 45-minute computing glitch at Knight Capital in August 2012 cost the firm $460 million. More recently, “latency” issues at the Chicago Mercantile Exchange (CME)—that is, delays between the time that CME computers execute trades and report them to the market—allowed some HFTs to take advantage of trading information ahead of others. Many fear the lack of required capital, opaqueness of their financial condition, and rapid trading algorithms pose a risk to trading-market integrity, stability, and trust.

Regulation

The SEC introduced rules against flash orders (a flash order is a marketable order sent to a market center that is not quoting the industry's best price or that cannot fill that order in its entirety) and imposed mandatory circuit breakers for trading platforms following the Flash Crash in 2010. Regulators in Europe and the United States have considered minimum resting times for orders, but most have resisted calls to ban HFTs.

In 2011, the SEC adopted a new rule (PDF) to help the SEC identify and obtain trading information on market participants that conduct a substantial amount of trading activity.

In 2015, the SEC issued a rule proposal (PDF) to require broker/dealers active in off-exchange markets to become members of a national securities association.

CFA Institute Viewpoint

CFA Institute believes HFT is not inherently manipulative or fraudulent, but the application of this “tool” by firms may lead to manipulative or fraudulent activity. Such actions by HFTs should be addressed through existing antifraud and antimarket manipulation rules. CFA Institute also believes that HFTs provide certain benefits to the market, including (1) narrower bid–ask spreads; (2) increased market liquidity in normal times; (3) improved price discovery; and (4) significant volume on transparent, traditional exchanges.

CFA Institute supports the right of firms to engage in HFT under appropriate rules and regulation:

  • Firms should be subject to meaningful regulation and oversight.
  • Firms should not have access to the market order book in the same manner as market makers unless they also are subject to market-maker obligations.
  • Firms should have to maintain controls and oversight of their trading algorithms to ensure that mistakes are addressed automatically and quickly.

We also do not believe that broker/dealers should bypass their own control systems by giving HFTs unfiltered direct market access. We believe that flash orders are a means of manipulating the market. Regulatory steps aimed at strengthening the testing and controls around algorithms and improving network resiliency, especially during bouts of volatility, should make markets safer for investors. Arbitrary restrictions on order submission are less likely to be effective.

 

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