The Effect of Corporate Governance on High Frequency Trading Habits

by Jennifer Gorton for The Race to the Bottom, October 15th, 2010.

The days of calling your broker to place a trade over the phone are over.  In fact, the new breed of Wall Street traders that are under 30 years old have probably never placed a trade over the phone.  In today’s trading world, billions of dollars are moved in financial markets with the click of a mouse.  This transition to electronic trading has made many market operations more efficient, but it has not come without costs.

The rise of technology and electronic trading has helped birth an entirely new method of trading—high frequency trading.  In high frequency trading, traders will hold trades for anywhere from a few seconds to mere milliseconds.  These trades happen so fast that humans could never execute them; instead, they are run by million dollar computers. 

Unfortunately for Wall Street traders, many economists and financial analysts are blaming high frequency trading for several major catastrophes over the last two years in financial markets.  The largest one is the Flash Crash that occurred in May 2010 as the stock market plunged nearly 1,000 points in a few minutes before recovering much of its losses in the next hour.

That day made it clear that high frequency electronic trading could be extremely dangerous, and, therefore, the scrutiny has intensified.  Lawmakers in Washington are pushing for much stronger regulation concerning high frequency trading; they have already passed laws that have made this style of trading more difficult, including the inability to hedge, or hold simultaneous long and short positions in one asset. (continue reading… )

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