Wharton Questions High Frequency Trading Softwares

A story about the questionable practices of High Frequency Trading, published in Knowledge@Wharton estimates that according to some calculations "high-frequency trading by investment banks, hedge funds and other players accounts for 60% to 70% of all trades in U.S. stocks, explaining the enormous increase in trading volume over the past few years. Profits were estimated at between $8 billion and $21 billion in 2008." According to Tim Quast, this practice is "responsible for 20-30% or more of volume currently."

Practically speaking, high frequency trading is the continual, tick-by-tick, high-turnover buying and selling with real-time data to control risk while generating returns from minute change, Quast writes. Now do you wonder why sometimes your buy or sell orders sit and wait there, while you see volume changing and your order is not being processed?

These types of software programs are designed to automatically front run investors. The information advantages that come with the high frequency trading can unnecessarily increase volatility and "cause retail and institutional investors to chase artificial prices, make markets less efficient and systematically transfer wealth away from ordinary investors," writes Alan Schram in Huffpost, who is the Managing Partner of Wellcap Partners, a hedge fund based in Los Angeles.

Indeed it makes a huge difference to be the first in line when trading stocks. However, at what cost? Is it all legal? Experts already raise their voices if the practice of using a high frequency trading software is a hazard to fairness in stock trading.

Does this practice put some investors ahead of the others? Yes it does. Therefore, if our faith in fair stock trading practices is shattered then who is going to invest and trade in the stock market? For this reason, an SEC type of scrutiny into the practice and use of high frequency trading softwares and even making of them is of high priority.

Written by Armen Hareyan