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High Frequency Trading and Price Discovery

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High Frequency Trading and Price Discovery

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High-frequency traders have a good pitch to make to markets.

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7

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  • Innovative

Recommendation

The May 6, 2010, “flash crash” and other past trading glitches have led policy makers to question the effects of high-frequency trading on markets. Coding issues and faulty algorithms have clearly ignited some notable incidents. However, trading mistakes caused problems in markets long before servers began executing trades in microseconds. Finance experts Jonathan Brogaard, Terrence Hendershott and Ryan Riordan offer a useful look into the day-to-day reality of high-frequency trading. Although their report will prove hard work for anyone but specialists, getAbstract recommends it for its valuable analysis of the effects of such trading.

Summary

High-frequency traders (HFTs) have, to some extent, replaced dedicated human market makers as providers of liquidity, becoming “a new type of electronic intermediary.” The obligation of traditional market makers to provide liquidity in a security does not apply to HFTs; neither does the restriction on demanding liquidity because of privileged information the market maker may have. In fact, it is not always easy to distinguish non-high-frequency traders (nHFTs) from HFTs, who may engage in diverse trading strategies for their own account or as brokers for third parties...

About the Authors

Jonathan Brogaard is an assistant professor of finance at the University of Washington. Terrence Hendershott is an associate professor at the University of California at Berkeley. Ryan Riordan is an assistant professor at the University of Ontario Institute of Technology.

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