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Securities Law Program Website

Experts Assess the Risks and Benefits of High Frequency Trading

 

Trading a security like stock or an option only to earn a fraction of a penny on the deal isn’t worth the effort. But multiply such trades tens of thousands of times per day and soon it starts adding up to real money.
 
That is why high-frequency traders do what they do: using sophisticated technological tools to trade securities, but holding them for very brief periods of time—from seconds to hours. Used mostly by larger, diversified firms, high frequency trading (HFT) relies on computerized algorithms to analyze incoming market data and implement proprietary trading strategies.
 
It is a game of speed that competes for very small, but consistent profits, and it can have a great impact upon the stock market in general.
 
The practice was the focus of “High Frequency Trading: Why is it done?  What are its dangers? Can we protect our markets?” a March 26 symposium held at the Columbus School of Law and sponsored by the Securities Law Program and the Securities Law Student Association.
 
A panel of three experts explained what HFT really is and how it works, discussed the risks it can pose to markets, and analyzed its role in the infamous “flash crash” of May 6, 2010.
 
Panelists included Christopher R. Concannon, (left) a 1994 alumnus of Catholic University’s law school, executive vice president, Virtu Financial LLC, and former executive vice president NASDAQ; James A. Brigagliano, partner, Sidley Austin LLP, and former deputy director, SEC Division of Trading and Markets; and Theodore R. Lazo, also a 1994 alumnus of Catholic University’s law school, and now general counsel, New York Stock Exchange – Regulation.
 
All agreed that the blinding speed of today’s high frequency trading poses major challenges to regulators.
 
“Today’s trader is an automated program sitting in a data center,” observed Concannon. “We have to figure out how to regulate them.” 
 
High frequency trading programs offer advantages and profit generation for many types of traders, but it can also pose a threat, causing gyrations by trading on market movement instead of basic underlying information.
 
That happened on May 6, 2010, when the Dow Jones Industrial Average’s suddenly dropped nearly 1,000 points, at one point falling 481 points in six minutes and then recovered 502 points just 10 minutes later.
Among the contributors to the “flash crash” were the HFT algorithms, programmed to react with a cascading frenzy of ultra-fast trades, causing a “hot potato” effect as securities were moved around without logic or scrutiny.  
 
The phenomenon alarmed SEC Chairman Mary Schapiro, who said at the time “High frequency traders turned what was a very down day for many investors into a very profitable one for themselves by taking liquidity rather than providing it. I think their activity that day should cause us to thoroughly examine their current role.”
 
There are tools on the way to help the SEC, FINRA, and other regulators keep up with the new trading technologies, noted Brigagliano. The SEC is pushing for the establishment of a consolidated audit trail system that would enable regulators to track information related to trading orders received and executed across the securities markets.
 
Summing up the informative afternoon, Professor Lipton said “this important aspect of today’s securities industry was brilliantly explained by three gifted practitioners, all of whom made significant sacrifices to be here today and to develop this program for us.”