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HFT stabilises modern markets - academic research

First Published 1st December 2014

New study examines the relation between high frequency trading and extreme price jumps.

A recent research paper, High frequency trading and extreme price movements, takes issue with allegations that HFT causes and amplifies price jumps, consequently harming market stability.

Instead, US and Canadian academics, led by the University of Washington's Jonathan Brogaard, found that during extreme price movements, high frequency traders act as net liquidity suppliers while non-high-frequency traders act as net liquidity demanders.

Moreover, high frequency traders are particularly active providing liquidity during price jumps that result in permanent price changes, absorbing the most informed order flow.

"Our evidence is consistent with HFT performing a stabilising function in modern markets," researchers wrote.

"An average HFT firm in our sample provides liquidity to aggressive informed traders during periods of extreme price fluctuations. As such, this firm acts to stabilise markets during periods of stress," the report said.

But there are some caveats. "It is important to note that not all HFTs act in a purely benevolent fashion during price jumps; we find that HFT liquidity demand increases too," the researchers found.

The issue is controversial because regulators from around the world are engaged in a high stakes battle trying to make rules for the use of technology in modern markets.

In response, Themis Trading, a firm founded by HFT sceptics Sal Arnuk and Joe Saluzzi, said: "This would be contrary to the findings of the Joint SEC/CFTC Flash Crash Committee and contrary to some of the best sourced papers written by the independent research analyst program of the CFTC." They also raise questions about the authors' financial backing, study's methodology and data sources.

The full research paper can be accessed here.