High frequency trading (HFT) has been given a dim verdict in a government sponsored review, undertaken by Professor John Kay.
The interim report described a "hostile" tone of submissions from financial market participants, who informed the research, towards high frequency trading. The review also criticised the impact of quarterly reporting on the behaviour of companies and their shareholders.
HFT, where trading is conducted in large volumes and driven by computer models, represents over half of trades on the London Stock Exchange, the report noted.
"Many respondents were critical of high frequency trading, some vehemently so," said the report.
"Supporters of high frequency trading claim that it increases liquidity and reduces price volatility," it said. "The majority of our respondents were sceptical of these claims. They asserted that overall volatility had not been reduced, and doubted that the liquidity which high frequency trading claimed to provide was real."
In a submission for the report, financial services firm Aviva said: "While some argue that spreads have reduced as a result of this activity, in reality the extent and depth of liquidity they really represent is questionable". This was "representative" of many other comments, the report said.
The Kay report noted the 'flash crash' of 6 May 2010 in the US stock market, but said respondents to research expressed "some doubt" about the precise role of high frequency trading in the problems.
Those who were against HFT, however, made "few suggestions as to how the volume of such trading might be reduced or the activities of high frequency traders restricted".
"One proposal was that orders, once placed, might be required to rest for a minimum period of time," it said.
This week, it was reported that Deutsche Borse in Germany was introducing fines for HFT traders who make large numbers of trade orders but fail to complete many of them. It described such trading as "abuse" of its network capacity.
The final version of the Kay report is due to be published later this year.
In reaction the report, Hugh Cumberland, business development manager at Colt, said: "A number of objective studies appear to show that HFT improves liquidity, reduces volatility and the cost of trading. However, subjective opinion that HFT is a bad thing seems prevalent. Suggestions that HFT volumes should be reduced or activities be restricted would appear to be based on sentiment rather than hard fact." Colt supplies technology to trading firms, among other companies.
"If there are demonstrable benefits to the market resulting from HFT, it would be a pity for these to be lost purely because of the negative light in which HFT has been cast – a case, surely, of throwing the baby out with the bath water," he added.
Photo credit KrakenHammer