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High-Frequency Trading - Essay Example

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High-frequency trading has for the past few years come under scrutiny as legislators, regulators, and media all over the world raise concerns of its potential market risks. It is a broad term that lacks precise regulatory and legal definition. It describes what many people…
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High-Frequency Trading
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"High-Frequency Trading"

Download file to see previous pages It is the latest technological tool in the history of securities marketing. They assert the trading has lowered trading costs (Shorter and Miller 1-2). They, however, fail to realize that HFT leads to phantom liquidity, engages in manipulative strategies, have systematic risks, and that some HFT firms are involved in front-running.
Although substantial evidence suggests that HFT provides market liquidity, it is not always the case. It at times fails to fulfill the liquidity-supplying function. The provision of liquidity by HFT is partially illusionary because it avails small order depth. This implies that HFT market makers usually quote narrow spreads without the will to sell or buy substantial quantities at the quoted prices. The low spreads, therefore, do not last and transacting significant quantities becomes impossible. In addition, it displaces other liquidity suppliers such as certified exchange specialists who are likely to endure in the market even during turbulent times. During the Flash Crash, for example, the sale of one large order caused HFT firms to gain substantial blocks of E-mini shares. As a result, many orders transacted at cheap prices and the index fell rapidly (Jones 1-3). Regulating HFT would, therefore, be important in order to caution liquidity when market conditions are not favorable. To remedy this problem, HFTs should run batch auctions at regular intervals. Under this regulation, exchanges can collect and aggregate available orders to trade securities. They would then be executed at the price when most offers and bids match (Shorter and Miller 34-36).
There is a growing concern that HFT in front-running by damaging price discovery processes. In other words, there is growing worry that HFT provides unreliable price information and makes conditions difficult for traders equipped with sound information. It diminishes the market’s potential to ...Download file to see next pagesRead More
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