High-Frequency Trading Special Report

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If the "stocks tornado" of May 6, which saw the Dow Jones Industrial Average head
south to the tune of nearly 1,000 points, has taught us anything, it's that the highfrequency trading phenomenon is a very emotive issue. This is the last thing the
high-frequency boys needed, given the US Securities and Exchange Commission's
(SEC) well-publicized fi xation with such strategies, which came to a head by way of
James Brigagliano's testimony before the Senate Banking Subcommittee on Securities, Insurance, and Investment on October 28 last year. "This quicker access could, for example, enable high-frequency traders to successfully implement ‘momentum' strategies designed to prompt sharp price movements and then profi t from the resulting short-term volatility," he testifi ed. "In combination with a ‘liquidity detection' strategy that seeks solely to ascertain whether there is a large buyer or seller in the market (such as an institutional investor), a high-frequency trader may be able to profi t from trading ahead of the large order."

At the time, Brigagliano's comments seemed a little melodramatic, but last week's
fiasco suggests that perhaps he wasn't too wide of the mark. I bet he's smiling now,
though.

Brigagliano's testimony was backed up in mid-January this year when the SEC
voted 5-0 to publish its so-called concept release on high-frequency trading, dark
pools and the structure of markets, a document that sketches out the Commission's
concerns surrounding the much-maligned practice, and invites feedback from market
participants - traders, exchanges and brokerages - which in all likelihood will lay the
foundation upon which the agency's future high-frequency rules will be based.
SEC chairman Mary Schapiro was quoted in the US press on January 13 insinuating
that the Commission would act in investors' interests, which, given its primary reason
for being - investor protection in the wake of the October 1929 Wall Street crash (even though the SEC was only offi cially founded some fi ve years later) - means that the US regulator would be inclined to act sooner or later. "Trading has accelerated from seconds to milliseconds," Schapiro said. "At the Commission, we must continually assess how changes in the market are affecting investors."

With comments like that, the writing is pretty much on the wall, I'm afraid.

What isn't certain, however, is what these rules will look like in their fi nal form, or
indeed how far they will go to impinge upon a strategy that according to certain estimates accounts for as much as 70% of US stock volume. My guess is that the SEC
will impose the types of rules designed to restrict the "downside" associated with highfrequency trading, while simultaneously allowing such strategies to continue. The only problem with that tack is how they would go about it. That's anyone's guess.

Click here to download the PDF