Forensics Journal - Stevenson University 2012 | Page 20

STEVENSON UNIVERSITY

Is High Frequency Trading the Problem
with the Financial Markets?
Corey E. Costa

INTRODUCTION

1. LIQUIDITY

High Frequency Trading (HFT) is a computerized means of capitalizing on minute changes in pricing and executing transactions quickly
using complex trading programs. Used honestly, it provides best execution for customers in the form of faster trades at better prices and
supplies liquidity to the marketplace. Implemented by the unscrupulous, it manipulates prices for the trading firm’s benefit, takes
advantage of other HFT firm algorithms, and fails to stabilize markets
in times of crisis. These negative effects are why regulators and many
financial market analysts are posing the question, “Should High
Frequency Trading be allowed and, if so, how do regulators encourage
the positive aspects of HFT while minimizing the negative?”

Investopedia defines liquidity as, “The degree to which an asset or
security can be bought or sold in the market without affecting the
asset’s price. Liquidity is characterized by a high level of trading activity. ” Using this definition, one would have to conclude that HFT
would improve market liquidity. But this definition, while acceptable in a pre-HFT world, is simplistic and misleading now. A more
accurate description of liquidity would require that a matching bid
and offer for a matching size and price are available when needed
(Sornette and von der Becke, 6).
Several researchers and analysts have provided input on the topic of
liquidity and provided data to both prove and disprove that HFT
firms provide liquidity, but most agree that, at least during the May 6,
2010 “Flash Crash,” even HFT firms did not provide adequate liquidity (Brogaard, 2010, 5). The “Flash Crash” resulted in an approximate
600 point drop in the Dow Jones over a five m [