High Frequency Trading May Magnify Market Woes

Aug. 11, 2011 -- This week's market flux is not identical to the flash crash of 2010 but experts believe that computer-driven high frequency trading is partially responsible for accelerating stock gyrations.

It has been a rollercoaster week for stocks. The Dow Jones industrial average fell by 600 points on Monday in reaction to U.S. debt downgrade by Standard & Poor's, then jumped 429 points on news from the Federal Reserve on Tuesday, but dove back down 520 points on Wednesday in reaction to bank stock worries in France.

On a volatile week like this one, some experts estimate that high frequency trading makes up 73 percent of stock market transactions.

High-frequency traders use automated tools programmed to react to patterns in the stock market--acting on new information faster that any human could. Specialized high-volume traders are known for the practice but some of the nation's biggest banks have evolved their trading operations to incorporate similar technologies.

But are the new trading platforms to blame for recent volatility or are faster systems merely amplifying a mood of uncertainty that was already underway?

"The use of electronic trading technology, the automated capabilities that become prevalent the market will tend to make markets go up and down quicker," said Sang Lee, a managing partner at the Aite Group.

Critics of this practice say that the automatic process can create a cascading effect that can over react to erroneous trades, potentially causing damage to stock portfolios and 401(k)s. And while there is no conclusive proof to show damage, some critics are already convinced.

"My personal opinion is that I don't believe that high-frequency trading should be allowed because it serves absolutely no economic purpose to anybody other than to people who are trying to make millions of dollars off of tiny little trades," said Peggy Cabaniss, president of HC Financial Advisors.