High-frequency trading: Order-based innovation or manipulation?
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ORIGINAL ARTICLE
High‑frequency trading: Order‑based innovation or manipulation? Viktoria Dalko1 · Michael H. Wang2
© Springer Nature Limited 2019
Abstract High-frequency trading (HFT) is a financial innovation that focuses on order flow and relies on quickly evolving information and communication technology. The innovation is successful, and HFT is highly and consistently profitable. However, the Flash Crash on 6 May 2010 exposed the unfamiliar side of HFT, thus illuminating the emergent need to unveil the negative impact that HFT has on other investors and the market. This paper examines data regarding quote-stuffing, spoofing, and market making provided by high-frequency (HF) traders, based on the increasing empirical literature. It first defines order-based manipulation (OBM) as the framework under which quote-stuffing, spoofing, and HF market making find common ground. It then provides details regarding how OBM is displayed in the three manipulation tactics. In essence, they all seek and exercise monopoly power in trading albeit through different ways of achieving it. The shared purpose is to gain monopolistic profit. The essence and common purpose explain why HF traders are not net liquidity providers, contrary to some proponents’ conclusions. Rather, this paper points out the three consequences that HF traders have brought to the market, i.e. increased volatility, increased frequency of unfairness, and instability potential. Recent regulatory improvement and completed prosecutions against manipulative HFT strategies justify the analysis. Keywords High-frequency trading · Order-based manipulation · Monopoly · Instability · Regulation
Introduction Financial markets are full of uncertainty. One main source of uncertainty is the impact of price-sensitive information flowing constantly into the market. Corporate announcements, analysts’ ratings, macroeconomic data, and breaking news are among the frequently encountered price-sensitive news events. However, some of those news events can be and have been manipulated for trading purposes. Numerous insider trading episodes have been recorded behind manipulation of earnings, spin of analysts’ recommendations, and other The authors thank Xin Yan for inspiration and session participants at EEA 2017 Annual Conference, 23–26 February, New York, NY, USA and SWFA 2018 Annual Conference, 7–10 March, Albuquerque, NM, USA, for their helpful suggestions. The authors also thank Dalvinder Singh, the Editor, for his advice. * Viktoria Dalko [email protected] 1
Department of Finance, Hult International Business School, 1 Education Street, Cambridge, MA 02141, USA
Research Institute of Comprehensive Economics, 435 Hancock Street, Quincy, MA 02171, USA
2
publicly disseminated information for the past 50 years [1, 2]. Insider trading with or without the assistance of manipulated insider information adds substantial uncertainty to publicly available information. Thus, it is risky to make investment decisions by relying on information content only. Sophistic
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