Well over a decade has passed since the Dow Jones infamously plummeted over 650 points in half an hour, wiping close to $9 billion off share prices, before rebounding to regain almost 10% of its value within minutes. Numerous “flash crashes” have taken place since, most notably the sterling flash-crash of October 2016.
It is still inconclusive to what caused the original flash crash with high frequency, fat finger and rogue trading all facing accusation since 2010. What we have learnt however is that the debate has moved away from looking at the flash crash as an isolated incident, towards a wider look at the influence, both positive and negative, of electronic market making. It is important that this debate, particularly in light of the recent dramatisation of Robert Harris’s Fear Index novel on Now TV, does not underplay the importance of understanding the pricing efficiency market makers bring to the industry.
The concerns around the buying and selling of stocks at breakneck speed is generally that it is the antithesis of traditional investment wisdom. People engaged in high-speed trading do not place value in staying in the market and allowing their position or portfolio to grow. What they care most about is waiting for their algorithm to buy when a particular stock or sector drops, then sell when it goes back up. As these stocks are being traded in milliseconds, certain people question if there is a level playing field given only certain firms can afford the highly sophisticated technology that fuels this form of stock trading. And those that don’t are at a significant financial disadvantage.
However, a less widely published view is that these computer driven market makers and hedge funds, like the Swiss firm in Harris’s novel, actually make it easier for investors and traders to buy and sell. Without this practice, it is argued, there would be a dramatic fall in transactions and less investment activity as a result. There is no doubt that the concept of analysing market information such as stock prices to implement proprietary trading activity in a matter of seconds, has many advantages. This includes greater market liquidity, lower transaction costs and faster access to pricing.
It is these advantages which, while underplayed in the TV drama, are at the heart of modern-day market making. In fact, numerous fund managers and dealers are even starting to make significant strides to improve their market maker relationships. This involves trying to glean more granular insights into how stocks are being bought and sold through in-depth reports that are derived from communications data. In addition, to ensure the best prices and quotes are never missed, some firms are even receiving a real time stream of information that feeds their pricing engines. As a result, these firms can automate the creation of indicative pricing and influence quotes being provided by the trading desks.
While Harris’s novel hitting our TV screens does little to provide any concrete answers to stopping future “flash crashes” from happening, it does make a wider audience stand up and take note, which can’t be a bad thing. But as a result of this series, it would be good to start witnessing a long overdue positive portrayal of market making. After all, it is not as if the information surrounding future events can’t be interpreted and then translated into reports. It is a trading practice that has meant one no longer has to stay in the market for an eternity in order to realise a profit. Sure, flash crashes will still happen, but this should not override the fact that more firms can now buy when a solid stock goes down and sell when that stock goes up thanks to the art of algo. Some will of course lose, but this should not mean fearing those who see faster profits.