The events of the past few days have reopened important conversations about the role of professional intermediaries using High Frequency Trading tools to provide liquidity during market ups and downs. It’s important for investors to understand why we have the best markets ever, especially in trading environments such as this one.
In a market sell-off, automated traders – including those called Designated Market Makers (DMMs) – at the New York Stock Exchange and the largest market makers on Nasdaq, used HFT tools to quickly stabilize the markets. Many of these firms have obligations to buy stocks when no one else wants to buy, and to sell when no one wants to sell. As noted by the NYSE, these electronic market makers – called DMMs — facilitate price discovery periods of substantial trading imbalances or instability. With their capital commitments, using HFT, such traders play a vital role in bridging the gap between supply and demand for stocks.
During market events like February 5, in which the Dow dropped 1,175 points in one day, or 4.6%, there were far more sellers than buyers. This steep decline meant that market makers faced a significant commitment to stay in the market. The influx of sell orders caused an imbalance in supply/demand and electronic market makers committed additional capital to support their stocks.
In such a volatile scenario, investors more than ever, want stock prices to reflect all available information as soon as possible, and the technology of our modern markets facilitate that process. HFT firms that are DMMs communicate trading information to trading participants on a regular basis. When large institutional investors want to put money to work in the market or take money out to meet redemptions, responsible HFT market makers are there to make sure they receive a fair price at that point in time. Perhaps even more importantly for the average Mom and Pop investor, HFT also plays an outsized role in facilitating the smooth trading and liquidity of innovative ETF products.
We live in a time where even in market downturns, an investor wanting to buy or sell a stock will be able to execute that order from their iPad in a fraction of a millisecond, enhanced by HFT participation, with modern trading technology delivering dependable liquidity in times of markets swings. It’s critical that we focus on the efficiency of that process rather than assigning blame for the market direction.
Arthur Levitt, former SEC Chairman
The Wall Street Journal, August 17, 2009