Thursday, October 1, 2009

High Frequency Vs Flash Trading

A Knowledge@Wharton article "The Impact of High-frequency Trading: Manipulation, Distortion or a Better-functioning Market?" discusses the current concerns about high frequency trading.
According to some estimates, high-frequency trading by investment banks, hedge funds and other players accounts for 60% to 70% of all trades in U.S. stocks.
Its defenders say high-frequency trading improves market liquidity, helping to insure there is always a buyer or seller available when one wants to trade.
"High-frequency trading involves investors with good computers taking advantage of small discrepancies in prices," says Wharton finance professor Marshall E. Blume. "Generally, economists think that drives prices back to where they should be....
Alarm bells started going off with news accounts this summer about "flash orders," a subset of high-frequency trading that exploits regulatory loopholes to give favored traders notice of orders a fraction of a second before they are transmitted to everyone else. Flash trading has been widely condemned as giving a favored few an unfair advantage.
"Some people are getting advantages that others aren't, and that may lead to abuse," says Wharton finance professor Franklin Allen. "It is a form of front running." Front running, which is generally illegal, means improperly profiting by using advance information to jump ahead of someone else's trade.
Flash trading now appears to be on the way out. In mid-September, the SEC proposed a ban, and the Nasdaq market quickly moved to prohibit the practice. A number of firms that had offered flash trading to clients have exited the business. The SEC ban requires a second vote by commissioners to become final.

Because many people have been unclear about the distinction, the flash-trading controversy has triggered worries about high-frequency trading, which involves strategies that appear to be perfectly legal.
Read the entire article here.

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