A Bank of England research report concluded that high frequency traders had a positive impact on UK equity markets, and did not “generally contribute to undue price pressure and price dislocations.” Two of the four authors of the report work for the Bank of England, while the other two authors are academics at the University of Cambridge and the University of Gothenburg. Although the report concluded that HFTs tend to buy and sell multiple and individual stocks more aggressively than comparable investment banks, “trading by HFT firms are associated with a permanent impact whereas … trading by investment banks is associated with only a temporary price impact.” The authors said this is because HFTs are more likely to react to “new information,” which tends to make market prices “more efficient.” Aggressive trading by an HFT tends to prompt more aggressive volume in the same direction of the trading by other HFTs in the next few minutes. Contrariwise, aggressive trading by an investment bank tends to lead to more aggressive trading by other investment banks in the opposite direction. Accordingly, said the authors, “correlated trading among HFTs are associated with a permanent price impact, whereas instances of correlated bank trading are, in fact, associated with future price reversals.”
My View: Contrast this BOE research report with an article by Gregory Scopino, an attorney with the Commodity Futures Trading Commission, entitled, “The (Questionable) Legality of High-Speed ‘Pinging’ and ‘Front Running’ in the Futures Markets,” that appeared earlier in February in the Connecticut Law Review (click here to access the article). Mr. Scopino’s composition suggests that high frequency traders in futures markets sometimes engage in an activity known as “pinging” that permits them to front run other traders. Through this activity, alleges Mr. Scopino, HFTs enter one-lot orders, receive their fill, and use this trade information to place other orders to the detriment of other market participants. Mr. Scopino claims that this type of activity may be illegal under applicable law and CFTC regulations. Although Mr. Scopino’s views likely reflect, at most, a minority view of applicable law, his article provides another example of the ongoing strong emotions engendered by HFT techniques. The BOE research report is a refreshing, dispassionate, quantitative look at the potential positive impact HFTs apparently have on liquidity in at least one market segment—UK equities.