23/10/2012: HFT restrictions and market efficiency

In my class on Investment Theory (MSc in Finance, TCD) we've discussed the issues relating to markets efficiency, HFT and relative speeds in newsflow and trading. We are going to talk more about this subject in my course on HFT in early 2013.

Here is the latest report on the effects of the EU regulatory interference in HFT.

Quote: "European Union plans to clamp down on trading shares faster than the blink of an eye could damage market efficiency and reduce liquidity, a UK government-sponsored paper said… A report by the Foresight Project, which was sponsored by the British government and gathered evidence from 150 academics and experts from 20 countries, said plans to force minimum resting times on orders could reduce liquidity."

The Project (led by John Beddington, the UK's chief scientific advisor) has found that:

• "...some of the commonly held negative perceptions surrounding HFT are not supported by the available evidence and, indeed, that HFT may have modestly improved the functioning of markets in some respects"
• "However it is believed that policymakers are justified in being concerned about the possible effects of HFT."
• "The report found no direct evidence that HFT increased volatility, nor evidence to suggest it has led to an increase in market abuse."
• "It said that computer-based trading could have adverse side effects in some circumstances and that these risks should be addressed."

As my students would know, I am of two views on HFT:

1. HFT is a necessary activity with inherent risks (as any other activity in the market) 
2. HFT can act in contradiction to the direct real-activity nature of the financial markets, but so can other financial instruments and strategies (e.g. hedging across non-asset-related risks, e.g. using Forex markets).