Regulate High-Frequency Trading in Real Time

Regulate High-Frequency Trading in Real Time

Edgar Perez, the author of “The Speed Traders: An Insider’s Look at the New High-Frequency Trading Phenomenon That Is Transforming the Investing World” and the forthcoming “Knightmare on Wall Street: Do Facebook’s Botched IPO and Knight Capital’s Technology Error Mark the Beginning of the End of Equities Investing?,” leads The Speed Traders Workshop 2012. He is on Twitter and Weibo.

Wrongdoing existed long before the advent of high-frequency trading, and it will always be a part of markets. High-frequency trading is simply a tool; it can be positive or negative for investors and markets. To maximize the benefit and minimize the downsides, regulators need to catch up with the technology.

High-frequency trading has been under a microscope since the infamous “flash crash” in 2010. Let’s remember, though: The market rebounded that day almost as fast as it fell, and regulators ultimately determined that the crash was initiated by human error. But many in the financial sector and in government were uncomfortable at the thought that high-frequency trading programs could vaporize huge amounts of equity in a matter of minutes.

With real-time data, regulators could see and stop erroneous activity like the 45-minute flurry of trades by Knight Capital.

These trades, like any other area of finance, should have sensible regulations imposed to promote sound trading practices and protect the average American investor from predatory behavior. If a market participant who does not use high-frequency trading believes that he or she cannot enter into fair transactions, then that individual will not invest in that market. But regulators could restore trust in the market without eliminating high-speed trading. They simply must be armed to analyze trading activity in real time.

In an area of finance predicated on speed, regulation must be as well. Real-time information would allow regulators to see everything that is occurring in the markets, no matter how quickly the order information is being posted and transactions are occurring. This would require significant commitments to invest in both human capital and information technology, but the investment is worthwhile: it is vital for regulators to level the playing field of high-frequency trading.

Just a few weeks ago, the Securities and Exchange Commission missed an opportunity to move in this direction faster; the commission approved a rulerequiring exchanges and broker-dealers to provide trade information to a central repository by 8 a.m. the next trading day, rather than in real time as it had been proposed originally. Although either requirement would take years to be implemented, the real-time option could have allowed regulators to immediately see and stop erroneous activity, like the 45-minute flurry of trades by Knight Capital on Aug. 1.

Real-time policing for potential malfeasance is the most efficient way to regulate high-frequency trading. Analysis of real-time data would provide for effective regulation of these trades. This in turn would provide peace of mind for market participants big and small.