The Institute Blog

Felix Salmon: Curb High-Frequency Trading and End the Stock Market “War Zone”

When Felix Salmon looks at the global equities market he sees a world of free-for-all electronic warfare that likely would be more recognizable to Isaac Asimov than Milton Friedman.

“The stock market today is a war zone, where algobots fight each other over pennies, millions of times a second,” Salmon writes in his recent column for Reuters and BuzzFeed. It’s an especially timely point in the wake of the Knight Capital fiasco.

Salmon’s point is based on this animated image, which shows the amount of high-frequency trading in the stock market between January 2007 and January 2012:

Notice how the total activity balloons as it gets closer to the present? To Salmon, this is a cause for great alarm.

“The stock market is clearly more dangerous than it was in 2007, with much greater tail risk,” he writes. “Meanwhile, in return for facing that danger, society as a whole has received precious little utility.”

In particular, Salmon questions the value that this increased activity has created. “Are spreads a tiny bit tighter than they might be otherwise?” he asks. “Perhaps, but that has no effect on stock-market returns for long-term or even medium-term investors.”

So why should the profits of a few speculators be defended when these activities provide no real benefit to society? They shouldn’t, Salmon suggests. Not anymore. His answer? A financial transaction tax – a solution Salmon himself opposed back in 2007.

The reason for his change of heart is simple.

“The potential cost [of high-frequency trading] is huge; the short-term benefits are minuscule,” Salmon writes. “Let’s give HFT the funeral it deserves.”

Click here to the column on Reuters

Click here to see Salmon’s breakdown of the images on Buzzfeed

Comments

0

What Mr. Salmon fails to describe are the social costs of this activity. Even if these costs are non-trivial, ample tools exist to address them. The whole point of capital regulation is the increase the private cost of risk-taking while reducing it's social costs. So the real questions are as follows:

1) Are the capital requirements for those engaging in this activity too low?
2) What should they be?
3) How should these be adjusted in relation to volatility?

Rather than creating meaningless charts showing an increase in high-frequency trading, the author should try asking more serious questions.

ps A similar chart would show an explosion of online payment activity from 2001 till now. It is riskier than other types of payment activity as there is more fraud but no one is discussing how to dismantle internet shopping.

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