High-frequency trading (HFT) may be in the regulators’ cross hairs for good reason, but a new paper finds evidence that HFT helps deter one form of market manipulation, involving market closing prices.
A new paper from a couple of academics at York University’s Schulich School of Business examines the impact of HFT on the frequency and severity of suspected end of day (EOD) price manipulation on 22 stock exchanges around the world, and concludes that the presence of HFT has “significantly mitigated the frequency and severity of end-of-day manipulation”.
In particular, it estimates that the number of suspected EOD price manipulation cases decrease by 29.16 cases per month due to HFT; and, given the average number of cases per month in the data is 36.56, it says this means that HFT decreases the probability of EOD manipulation by 82.0%. And, it says that HFT is associated with a decrease in the total trading value surrounding suspected EOD manipulation by an estimated 49.2% at the low end.
While it’s hard to pinpoint the actual start of HFT in a particular market, it uses changes in trading activity that are typically associated with HFT (a large number of orders with smaller order quantities, and short holding periods) to infer the presence of HFT, along with factors such as the availability of direct market access, which is a prerequisite for HFT.
The paper gives a couple of possible reasons for HFT to help curtail market manipulation. “First, exchange surveillance systems are designed to pick up patterns of illegal manipulation, and not one-off manipulation. HFT orders are by definition following a computer algorithm, and therefore HFT systems set with the view towards manipulation are much more likely to set off a real-time alert to a securities surveillance officer,” it says. And, second, the more efficient markets that result amid HFT (higher liquidity, lower spreads) may make it tougher for manipulators.
Moreover, the paper finds that the effect of HFT is more pronounced than trading rules, surveillance, enforcement and legal conditions in curtailing this sort of manipulation.
“Overall, our findings imply HFT makes it more difficult for market manipulators to manipulate EOD closing prices,” it says. “It may well be the case that future efforts in monitoring HFT are warranted among policymakers and surveillance authorities, but such efforts should not inhibit the role of HFT in facilitating a reduction in EOD manipulation.”