Our view on Wall Street: Time to put the brakes on high-frequency stock trades
Although this month's "flash crash" on Wall Street has yet to be fully explained, the machine-driven market meltdown has cast an unflattering light on something called high-frequency trading.
High-frequency trading uses sophisticated computer algorithms to determine when a stock is likely to tick up or down. Some of these systems buy and sell hundreds of times in the space of a second, making tiny profits each time. By some estimates, high-frequency trading now accounts for more than half of all stock market volume.
Attention is focusing on the interplay of differing rules among the various exchanges — the heavy volume of computer trading undoubtedly amplified the problem. In the future, it could increase the odds of another, more severe event that further undermines investor confidence.
And for what? Rapid-fire trading serves no larger purpose. It does not raise capital for companies, create jobs or stimulate innovations in the broader economy. The trades are completely divorced from underlying economic fundamentals, and the traders know little or nothing about the companies their computers are feverishly buying and selling.
In addition to their potential for wreaking havoc, high-frequency traders impose costs on more traditional investors. By jumping in and out of securities in search of dips, they decrease the chances that a conventional investor might get a stock on a down tick. A study by the accounting firm Grant Thornton concluded that "the current stock market model forces Wall Street to cater to high-frequency trading accounts at the expense of long-term investors."
Making matters worse, these traders sometimes enter into murky ethical areas. The Securities and Exchange Commission is already trying to stop so-called flash orders, the superfast posting of potential trades used to improperly gain information before others. With a veritable arms race of new players and faster computers, it is not hard to envision more of this type of trickery taking place in the future — all too fast for human supervision.
High-frequency trading might also be diverting Wall Street's attention from more productive activities, such as underwriting initial public offerings of stock. It is certainly diverting computer engineering talent that could be put to far better use at companies such as Google or Microsoft.
For these reasons, high-frequency trading should be discouraged. Perhaps the easiest way to do this would be to require that exchanges charge more for orders. If superfast traders had to pay what you do to make a transaction with your Schwab or E-Trade account, you can bet it would put a damper on their hyperactivity.
Backers of these traders, who range from geeks in garages to titans such as Goldman Sachs, argue that they provide a service by adding "liquidity" to the market. This is true. But it is also a clever way of saying that what these traders do — increase trading volume — is inherently a good thing.
It is not good if it can cause a market crash. It is not good if it means those with the fastest computers get the best deals. And it certainly isn't good if it means those with the fastest computers can manipulate the system to their advantage, leaving the impression that the stock market is a rigged game for Wall Street sharpies.