Every time someone finds out I work with high frequency traders, they want to talk about the May 6 Flash Crash even though it happened seven months ago. The recent Securities and Exchange Commission report has reinvigorated debate. Everyone with an opinion or agenda regarding high frequency trading, algorithmic execution and market microstructure is using the report to back up their arguments.
In all the conversation about the crash, the real historic change is going unmentioned. In the very last paragraph of the Lessons Learned section of the report, the authors note: “another area of focus going forward should be on the integrity and reliability of market centers’ data processes, especially those that involve the publication of trades and quotes to the consolidated market data feeds.”
This is a key insight – late in coming – that will expand over time. Traditionally the SEC has focused on regulating the behavior of market participants, identifying deliberately malicious behavior or patterns of behavior. But now they are beginning to realize that data processing, integrity, and reliability can be just as important. The efficient functioning of markets is in just as much danger from software system failures as it is from malicious traders.
These system failures don’t result from market manipulation. In highly liquid markets covered by HFT firms, attempts at market manipulation are easily noticed or even unprofitable. Other HFT firms are always ready to profit from inaccurate prices, and the open nature of modern markets prevents the formation of cartels. Market manipulation alone is not sufficient to bring about a flash crash.