Market Efficiency & HFT
Does High Frequency Trading help or hurt the market? This is one of the biggest debates in modern finance.
The Efficient Market Hypothesis (EMH)
EMH says prices reflect all available information.
- HFT Argument: HFTs incorporate information into prices (from news, correlated assets) in milliseconds. This makes the market More Efficient. Prices are "stale" for less time.
Arguments FOR HFT (Pros)
- Lower Spreads: Competition among HFT Market Makers has driven spreads on blue-chip stocks to near zero (1 paisa or 1 cent). This saves retail investors money.
- Higher Liquidity: It is easier to buy/sell large amounts (in normal times).
- Price Efficiency: Arbitrageurs align prices across markets instantly (e.g., Nifty Futures vs Nifty ETF).
Arguments AGAINST HFT (Cons)
- Predatory Trading: Front-running, Order anticipation, and sniffing out institutional orders.
- Phantom Liquidity: They provide liquidity when it's calm and flee when it's volatile (Flash Crash).
- Inequality: It creates a two-tiered market. Those with speed (Co-lo servers) win; everyone else loses.
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Note
Conclusion: Regulators generally accept HFT because the lower spreads benefit the vast majority of investors, even if the "Flash Crash" risk is a scary side effect.
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