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October 01, 2009

High frequency trading

It looks like high frequency trading is going to be banned. Which seems to be a very silly decision indeed, because people have got it confused with flash trading, which probably should be banned.

High frequency trading, or abitrage trading, is simply a form of arbitrage using high speed computers. We like arbitrage, for it makes markets more efficient. Flash trading is open to abuse like front-running: we don't like market abuse and we don't like front-running. However, to ban the former because of the latter is absurd.

This whole process is called "arbitrage". It's been around for eons: Roman emperors buying cheap grain in Egypt and selling it in high priced Italy could be said to have been involved in arbitrage. A huge amount of foreign exchange trading today is arbitrage. Buying a stock on the London Stock Exchange and selling it on the NYSE to make a profit if the prices diverge is also arbitrage. (There is also time arbitrage, buying now to sell later, but that is better described as speculation. "Pure" arbitrage involves buying and selling in two different markets simultaneously.)

 

High speed trading is simply a subset of this arbitrage: using very high speed computers to do the buying and selling, faster than any human could hope to. In fact, so fast are these trades that the speed of light becomes something of a limiting factor. No, really: those with computers closer to the main stock exchange computers do better than those with theirs further away. The speed at which the information flows over the internet becomes a factor in determining how well it all works. That will indeed privilege the bigger players, who can afford to pay for their servers to get prime position but so what?


October 1, 2009 in Finance | Permalink

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