Can High-Speed Trading Be Slowed Down?

Updated

In the time it takes to say "algorithm," millions of stock quotes have been generated by so-called high-frequency traders. Using superfast computers and wide data pipelines, HFTs can flood the market with buy and sell orders at staggering speeds to make big bucks out of small market inconsistencies.

That's great for those traders, but not so wonderful for the rest of us. There's no way individual investors could ever keep up with HAL and his digital minion. We would always be at the mercy of the inevitable computer crashes of the kind that created the "Flash Crash" panic of 2010, which dropped the Dow Jones Industrial Average (INDEX: ^DJI) nearly 1,000 points. Imagine being invested in Boston Beer (NYS: SAM) , for example, and watching its share price plunge to $0.01, as did happen momentarily.

Facebook's (NAS: FB) ballyhooed IPO was put in jeopardy last May when its offering was delayed for 30 minutes by technical problems, followed by an overwhelming number of buy orders, which was then followed by a 17-second halt in all trading on the Nasdaq.


According to Eric Hunsader, CEO of data tracking firm Nanex, "High-frequency traders absolutely caused this."

Even large financial services firms are not immune from out-of-control automated trading. Last August, Knight Capital Group (NYS: KCG) was victim to a 45-minute period of automated trading glitches that cost it $440 million from the trades alone, and an 80% drop in its own share price.

Too late to stop it?
From 2006 to 2011, the amount of high-speed trading in the U.S. has more than doubled, from 26% to 55%, according to the Tabb Group, a financial consulting firm. But it's only now that this automated trading is receiving public congressional attention.

Last week, a former high-frequency trader gave written testimony to a Senate panel that said high-speed trading is a threat to the market. "U.S. equity markets are in dire straits," David Lauder wrote. The complexity of the trading technologies these days is baffling even to very experienced investors, he added.

High-speed trading has created a "casino-like environment," Andrew Brooks, a T. Rowe Price Associates vice president, told the panel. "[T]he almost-myopic quest for speed has threatened the very market itself."

Larry Tabb, CEO of the Tabb Group, told the senators, "We've gotten faster than we can possibly handle. The challenge is how do you stop it, and what happens if you stop it?"

Proposed speed traps ... but not here
While the Commodity Futures Trading Commission is struggling to define high-speed trading here in the U.S., European governments have started trying to control it. This week, the German government drafted a bill that would require high-frequency traders to be registered and to design their trading systems so as not to disrupt the markets. The bill also addresses the problem of "quote stuffing," the practice of burdening the market with high-speed orders that are quickly withdrawn. The proposal would require traders to balance their orders with their actual transactions.

In other European action, where the Tabb Group estimates 38% of trading is executed by high-frequency traders, France has imposed a tax on high-frequency trading, the U.K. is contemplating new regulations, and the European Union has called for a minimum half-second delay between the order being placed and the execution of the trade.

The German bill is a start, but some don't think it will do enough. The party in opposition to Chancellor Angela Merkel wants a minimum holding period to be imposed to slow down the trading. "This bill is a slow train versus the speed of light," said Carsten Sieling of the Social Democrats party.

But a slow train of a solution to high-frequency trading is still preferable to the snail's pace we're getting in the U.S.

If you are a dividend investor, then you're probably not going to get into high-speed trading yourself. What you need are companies that are relatively unaffected by the daily volatility of the market -- and also provide a steady income stream. Learn about three such companies in this free Motley Fool report!

The article Can High-Speed Trading Be Slowed Down? originally appeared on Fool.com.

Fool contributorDan Radovskyhas no financial position in the above-mentioned companies. The Motley Fool owns shares of Facebook and Boston Beer.Motley Fool newsletter serviceshave recommended buying shares of Boston Beer and Facebook. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.

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