Dust flux, Vostok ice core

Dust flux, Vostok ice core
Two dimensional phase space reconstruction of dust flux from the Vostok core over the period 186-4 ka using the time derivative method. Dust flux on the x-axis, rate of change is on the y-axis. From Gipp (2001).

Tuesday, August 23, 2011

Can HFT hold up the market?

Now here's a funny thought. Market volatility has been unpleasant, to say the least just lately. Liquidity has vanished, thanks to HFT. Arguably, the S&P 500 should be a good deal lower than it is.

Suppose you are an institutional holder of shares, and your models are telling you to sell; but every time you try, liquidity vanishes and you end up completing your sale at a much lower price than anticipated. Your boss yells at you. Worse, your year-end bonus suffers. So what do you do?

What can you do? Any attempt to sell in size collapses the price of the security in which you are trading. You have to come up with a strategy to minimize your losses in selling. Either you limit your orders, which means under the HFT regime they never fill (except for a handful of shares), or you don't sell at all. It's possible that some of these institutions are locked into positions they can't get out of (except at desperately lower prices).

There could be a whole country full of institutions that want to sell but dare not for fear to the scalping they'll receive from the algo traders.

Here is another "gift" HFT has given us. Liquidity on the buy side has already vanished; now liquidity on the sell side is going too. The likelihood of a fair price discovery through the market has taken another beating. Although arguably this allows the market to levitate at far above reasonable value, it also means long years of pain for "investors" as every tick up is desperately sold.

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