The thought of ultra fast machines dictating the financial markets is headline news (again) as regulators from Germany highlight the need for monitoring the lighting speed-trading strategies that pose as potential dangers to the market. European markets have been lucky to stay clear of the many dangers high frequency trading offers. HF traders use sophisticated automated trading systems to send multiple orders to the market to increase volatility and price movements, they consequently cancel orders thus creating a false idea of volatility at certain levels in the market.
The german regulator BAFIN, currently does not have any mechanism in place to monitor or police high frequency traders, BAFIN plans to introduce new legislation that monitors the trading of registered high frequency traders and monitors rogue traders who are out to spoil the efficiency in markets and creating a European equivalent of the 2010 flash crash.
The proposed regulation is a preventive measure that will make it illegal to manipulate markets using strategies employed by the high frequency traders. BAFIN’s main concern is HFT firms who constantly create false liquidity in the market by sending price requests but have no intention to trade.
“We are on the right path – the finance ministry has made convincing suggestions,” Klaus-Peter Flosbach, a finance expert for Chancellor Angela Merkel’s conservatives, informed the media
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Regulators across the Atlantic Ocean addressed the topic in March 2012. A senior government official at the CFTC (US regulator) initiated a new set of rules for high frequency trading firms to be registered as high frequency traders with the CFTC thus ensuring that proper risk and monitoring procedures are in place to avoid any major pitfalls.
HIgh Frequency Trading is commons in the equity markets and in the US accounts for 70% of trading. Europe is slowly following with around half the amount falling under the HFT. Asia has been developing its hardware and software to push ultra low latency trading with new data centres set up by Equinix.
High Frequency Trading affects the Forex markets in different ways. With 5 major venues accepting orders, in the inter dealer and ECN markets HFQ traders have a choice of hitting a price at any one of these venues.
FX is traded as a OTC thus creating additional difficulties for regulators to police the product. The new proposals by the German government are welcomed by market participants as another set back like the flash crash could have far more implications on the markets.