High Frequency Trading : Assessing a Proposed Ban on Flash Trading

Abstract

High frequency trading (HFT) started to grow in dominance at the tum of the 21 51 century and by 2009 it accounted for 73% of all trading. In recent years, HFT activity has been in decline for a number of reasons including lower trading volumes and volatility. The industry has also grown more competitive as more firms have entered the market in search of profit. Currently, the academic literature on how HFT affects elements of market quality such as liquidity, efficiency, and price discovery is ambiguous at best. Academics still intensely debate whether HFT has a positive or negative influence on the market and the average investor. While some studies indicate that HFT improves overall market quality, events such as the Flash Crash and Knight Capital Group trading fiasco have tarnished the industry's reputation. Unsurprisingly, regulators started to take interest in HFT. This study evaluates the effectiveness of a proposed policy to ban flash orders. For a number of reasons, data was not available and this was a major shortcoming of the study. It is still valuable, however, in that it discusses relevant theories and provides a foundation upon which to build in the future when better data can be used. This study has several contributions to the literature. First, it highlights two potential effects- improved investor confidence and reduced liquidity- of the policy that should be studied more closely in the future. Second, it underlines the importance of developing multidimensional policies, lest key risks of HFT remain unaddressed.