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.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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