Tuesday, August 14, 2012

High-Frequency Trading and Short Termism

The Economist has a piece that advocates a cautious approach towards high-frequency trading. It argues:
This newspaper seldom finds itself on the side of restraining either technology or markets. But in this case there is a doubt whether the returns justify the risk. Society needs a stockmarket to allocate capital efficiently, rewarding the best companies with higher share prices. But high-frequency traders are not making decisions based on a company’s future prospects; they are seeking to profit from tiny changes in price. They might as well be trading baseball cards. The liquidity benefits of such trading are all very well, but that liquidity can evaporate at times of stress. And although high-frequency trading may make markets less volatile in normal times, it may add to the turbulence at the worst possible moment.
The argument appears to highlight the tendencies of high-frequency trading to generate more short-termism in the market. This is to be contrasted with the incentives of long-term investors, which the closing observations in the Economist piece quite elegantly capture:
The most successful investor in history, Warren Buffett, says his ideal holding period for shares is for ever. So it surely will not do much harm to investors if, on occasion, they have to wait a second or two before dealing.

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