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Is Computer-Driven Trading Causing Market Spikes?

Filed by KOSU News in Business.
August 19, 2011

Stock prices lost more ground Friday, but the losses were small compared with Thursday and the stomach-churning drops of the week before.

The Dow Jones industrial average fell 173 points, or about 1.6 percent, after big drops in Asia and Europe. The sell-off has come amid worries about a global economic slowdown

But many people believe the decline has been aggravated by the explosion of high-speed trading.

Joe Saluzzi of Themis Trading has been watching the turmoil on Wall Street over the past few weeks, with huge volumes of shares being bought and sold, and triple-digit swings in the Dow nearly every day.

Saluzzi says many of the trades are coming from one source: “Some people are estimating that 75 percent of the volume is high-speed trading. Well, that only leaves 25 percent of real investors … which are institutional and retail.”

High-speed traders use supercomputers to find discrepancies in stock prices. Then they use the data they collect to rapidly buy and sell shares — sometimes in tiny fractions of a second.

Critics like Michael Greenberger, a former member of the Commodity Futures Trading Commission, say high-speed trading distorts the market. You need expensive supercomputers to play, and only the richest traders can afford them.

“Most rational people have to believe it is not a healthy way for the market to operate, where you’re trying to game the market by getting in ahead of human decision-making,” Greenberger says.

But critics also say there’s another problem. High-speed traders can pile on a stock trade, making price swings bigger than they normally would be. “High-frequency trading will amplify a move, whether it’s to the upside or to the downside,” Saluzzi says.

High-speed trading was blamed for the “flash crash” in May 2010, when the Dow lost and then regained hundreds of points within minutes. And Greenberger says high-speed traders could be responsible for some of the volatility now being seen in the markets.

“There is a conventional wisdom that the high-speed trading is aggravating the downside and the upside in this volatility,” he says.

Greenberger says there’s no way to know this for sure. Analyzing market swings is enormously difficult and takes more resources than overstretched federal regulators have right now.

James Angel, associate professor of business at Georgetown University, says high-speed traders have become a kind of convenient scapegoat in volatile times like these, but he doesn’t believe they have the kind of power people ascribe to them.

“Most of the time they are darting in and out with small amounts of money for fairly small profits,” he says. “They are not the people moving $40 billion in and out.”

Angel says what’s driving the market swings right now are very real fears about Europe’s debt problems and the slowing global economy. High-speed trading may be playing a role in that, but it’s not clear how big, he says.

What’s clear is that high-speed trading is a relatively new phenomenon that is reshaping the markets, and regulators don’t yet understand the real impact it’s having. [Copyright 2011 National Public Radio]

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