Question

High-frequency trading (HFT) refers to algorithmic trading in financial securities transacted through supercomputers executing trades within microseconds or milliseconds. They are characterized by high speeds, high turnover rates, and high order-to-trade ratios that leverages high-frequency financial data and electronic trading tools.

Read the following articles and discuss the following topics:   High Frequency Trading: Overview of Recent Developments

How Does High-Frequency Trading Impact Market Efficiency?

The real problem with high-frequency trading  

Do you think HFT makes the financial market more efficient? In other words, do the security prices reflect their fundamental values better because of HFT? What are some of the concerns regarding the HFT?

Answer 1

High-frequency trading can augment and bolster market efficiency. This is because high-frequency trading leads to reduction in the bid-ask spreads and this reduces the trading costs. It should be noted that bid ask spread is the differential that exists between the offered buying and selling prices. Market efficiency is also improved as short term volatility is lowered. As short term volatility is lowered there will be a positive impact on the overall liquidity levels.

The real problem with high frequency trading is that it makes the markets fragile. This is because it can amplify the level of systematic risk. As financial markets are now inter-linked more than ever before high frequency trading can transmit and relay shocks in a rapid manner from one market to another market and this can significantly amplify systematic risk.

Yes, I do think that HFT makes the financial market more efficient and that security prices reflect their fundamental values better because of HFT. This is because in some cases when traders use computing machines to monitor and regularly interpret electronic news feeds then material information is identified and trade is done. The price will then reflect the information and financial market will get more efficient. Some of concerns regarding HFT are with regards to different risks like operational risks, market shock risks, risk of making critical risk mitigation less effective and reduction of settlement risk mitigation.