Wednesday, September 28, 2011

High-frequency trading: taming the chaos

I have an opinion piece that will be published later today in the next few days in Bloomberg Views. It is really just my attempt to bring attention to some very good points made in a recent speech by Andrew Haldane of the Bank of England. For anyone interested in further details, you can read the original speech (I highly recommend this) or two brief discussions I've given here looking at the first third of the speech and the second third of the speech.

I may not get around to writing a detailed analysis of the third part, which focuses on possible regulatory measures to lessen the chance of catastrophic Flash Crash type events in the future. But the ideas raised in this part are fairly standard -- a speed limit on trading, rules which would force market makers to participate even in volatile times (as was formerly the case for market makers) and so on. I think the most interesting part by far is the analysis of the recent increase in the frequency of abrupt market jumps (fat-tail events) over very short times, and of the risks facing market makers and how they respond as volatility increases. I think this should all help to frame the debate over HFT -- which seems extremely volatile itself -- in somewhat more scientific terms.

I also suggest that anyone who finds any of this interesting should go to the Bank of England website and read some of Andrew Haldane's other speeches. Every one is brilliant and highly illuminating.

40 comments:

  1. Why do we want to reduce flash crash?

    It is a huge profit opportunity for those with a time horizon longer than a few minute (i.e. buy low). Also, those with burnt fingers will eventually learn.

    ReplyDelete
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  2. > why reduce flash crash?

    Mainly because the phenomenon is a result of market maker interactions which were intended to be a supporting and stabilizing force, not a source of risk.

    If everyone could throw their own 200 lines of carefully chosen autonomous trading code into the ring, then perhaps it would be a fair game.

    ReplyDelete
  3. You are making an assumption that given the positive and negative reinforcement mechanisms I've mentioned, the system will still not adopt and self correct.

    I for one would welcome such outcome since my time horizon is way longer than a few minute. I'd welcome a market that doesn't self correct!

    On the other hand, I'd not bet on it. Highly profitable opportunity are very infrequent events.

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