Question

5. Stock trading in the US has come to be dominated by high frequency traders. At the same time, technology and regulation have tended to fragment the US equity market through development of alternative trading systems (i.e., there are now many markets on which to trade). Discuss the trading problems for the institutional investors in this environment. In what ways is market quality better or worse as a result of these changes?

Answer 1

It is true that stock trading in the global market not just in US is denominated by high frequency traders. With their algorithms searching for opportunities quickly and executing them faster in fraction of seconds which is not feasible for human trader. These high-end algorithms have divided the market into so called algorithm traders and manual traders. Algorithm send their order to exchanges where they can be executed faster than, be it on any exchange or any ECN or any other alternative trading exchange. The problem for Institutional investors is even though some of them do have access to smart algorithms, they often face issues with regulators. Regulators do understand that algorithms are putting retail traders at disadvantage. In recent years regulators have brought in restriction, like regulation on short selling, making sure that short sell is not being used to manipulate the market. Increasing the tax on short term gain. Intuitional investor is often also blamed for creating high volatility in the market. Also creating smart algorithms is not a small task, it takes years and lot of expenditure to create an auto execution algorithm and it might also happen that at the end the algorithm might not be profitable. In some ways market have become better, the spread has gone down, the brokerage cost has gone down, the volume is high so any asset can be bought and sold very quickly, market value of asset is easy to determine. In many ways market have improved over the years and cost of transaction has gone down significantly but it has also come at the cost where the retail traders are put at disadvantage. Algorithm, sometimes send wrong orders which might cause market to crash or loss of the company so much that it might go bankrupt.