High frequency trading: Update
I’d like to make an update to my earlier rant about high frequency trading. I got an awesome comment from someone in finance that explains that my main point is invalid, namely:
…the statement that high frequency traders tend to back away when the market gets volatile may be true, but it is demonstrably true that other, non-electronic, non-high-frequency, market makers do and have done exactly the same thing historically (numerous examples included 1987, 1998, various times in the mortgage crisis, and just the other morning in Italian government bonds when they traded 3 points wide for I believe over an hour). While there is an obligation to make markets, in general one is not obliged to make markets at any particular width; and if there were such an obligation, the economics of being a marketmaker would be really terrible, because you would be saying that at certain junctures you are obliged to be picked off (typically exactly when that has the greatest chance of bankrupting your enterprise).
My conclusion is that it’s not a clear but case that high-frequency traders actually increase the risk.
By the way, just in case it’s not clear: one of the main reasons I am blogging in the first place is so that people will set me straight if I’m wrong about the facts. So please do comment if you think I’m getting things wrong.