Computerized global trading 24/6: a roller coaster ride ahead?

• Author: Malmgren, Harald

The "flash crash" on May 6 last year generated growing anxiety among investors that the accelerating speed of computerized stock trading was threatening to spiral out of control. As the weeks wore on, it became evident that the computerized operations of high frequency trading firms (HFTs) had taken a dominant role in equity markets--accounting for roughly 60 percent of daily trading, although at times surging to upwards of 80 percent. It also became evident that a multiplicity of alternative trading platforms, the continuously accelerating speed of orders, and the complexity of algorithm-driven trades had overwhelmed the capability of the Securities and Exchange Commission to monitor markets. Eventually the SEC and Commodity Futures Trading Commission collaborated, and appointed a group of experts to study what had taken place on May 6 and make recommendations about how to prevent future market breakdowns. Focusing solely on U.S. equity trading, the experts reported on February 18, 2011, and made fourteen useful recommendations, but were unable to fully explain the May 6 events.

The SEC did initiate various remedial measures, including circuit breakers and narrower bid/ask spreads. Confronted with growing complexity of trading across thirteen exchanges with differing time limits for execution, and substantial trading in at least forty dark pools, the SEC concluded that it could no longer provide adequate market oversight without requiring all traders to "tag" their transactions. For this purpose, the SEC initiated a "Consolidated Audit Trail" that would permit the SEC to track all trades. Public hearings brought to light that although the volume of trading by HFTs had eclipsed the traditional role of market makers, HFTs did not have the same obligations to remain active throughout the trading day. While HFTs provided a larger share of market volume, they were free to withdraw trading whenever they wished, potentially siphoning off massive liquidity whenever they turned off their algorithms. Regulators did discuss whether HFTs might be required to behave as "market makers," but without agreement.

Hearings also revealed the widespread practice of issuing thousands of "flash orders" (execute or cancel, with duration of millionths of a second) to probe for price differentials among exchanges, other trading platforms, and dark pools. Some SEC officials considered subjecting such orders to minimum duration of at least several seconds to limit...