Irreverent Economics

So are there systemic consequences from HTF?

Well yes, the people doing this are using possibly significant intra-day leverage, meaning some of the players could get into into trouble real fast. And that has a potential to disrupt the markets.

Still, its still early days in this, but the SEC is doing right in looking at HTF.

Of course, the situation SEC is discussing is different than 1987 as blogged here yesterday.

But who looses from HFT?

If HFT is used to front run regular investors, that will cause large losses to those investors, but alas, that is already illegal.

The profits from HTF rather come from the other HTF traders, and I find it hard to see how long term investors could suffer much from HFT, on average. There is efficiency to be had in execution, but the regular investors were not benefiting from that anyway, and so long as there is no front running, I think regular investors are not unduly affected by HFT.

Maybe the system? as discussed here tomorrow?

Ars technica has an interesting article on high frequency trading (HFT). Seems like the SEC does not like it. What are the pros and cons to regular investors, and society.

This is not the first time such discussion have come up. For example, back in 1987, automatic computerized trading was blamed for the crash, but the computers were a strawman.

The 1987 stock market crash, Black Monday,  is the biggest stock market crash since the 19th century with global stock markets fall by 23%.

The reason why the crash happened was automated trading strategies, in particular portfolio insurance (PI). With PI, an investor wants to insure against prices falling. Now an easy way is to buy a put option, but what if they don’t exist for a particular stock, or are to expensive. Enters PI, a dynamic replication of a put.

Dynamic trading of this type uses computers to execute trades more or less automatically.

It was all working fine, but investors were ignoring liquidity risk. A dynamically replicated put is not a regular put.

PI means that one sells when prices fall, and buys when the price rise. It can endogenously cause prices to fall. by generating precisely the kind of vicious feedback loops that can destabilize markets.

The computers were the instrument in this folly, but the real mistake was allowing so much of the market cap follow a single trading strategy. Still, many people blamed the strawman — computers.

But the underlying problem was portfolio insurance.

For more on this see here.