More and more trading, meantime, is being driven by high-frequency traders. There are grounds for thinking that their activities, which now account for a majority of the trading volumes on exchanges, are not good for the integrity of the markets. While HFTs claim they have brought about a narrowing of spreads and greatly increased liquidity, the liquidity can vanish in an instant, as it did in the notorious “flash crash” of May 2010. Unlike market makers, the HFTs make no commitment to remain active under all circumstances during all trading hours. So the liquidity is illusory and the risk that HFTs will cause liquidity to implode makes them systemically dangerous.
Note, too, that the ability of these traders to deal in microseconds gives them an asymmetric information advantage. For example, they initiate great quantities of “flash orders” to find out the depth and breadth of the market and establish whether there are willing buyers at a level above the most recent trades. Such small “execute or cancel” orders, carried out in millionths of a second, are designed to ferret out buyer limits to prepare for trades that are the equivalent of front running. (...)
James Tobin’s original intention was to throw sand in the wheels of what he called “excessively efficient” markets. Today’s markets are excessively fast, but their claim to be efficient is highly questionable. So the case for throwing sand in the wheels is that much greater. A tax on financialisation might well kill off high-frequency trading. Or it could be tapered on a sliding scale related to volume and holding periods. The important thing is that the rates should not be pitched too high, as in the Swedish experiment. If this reduces employment a bit in the City of London, so be it – it will release people into more socially useful activities.
It is a paradoxical result of increased competition from off-exchange trading platforms and from regulatory developments such as Europe’s Markets In Financial Instruments Directive that long-term investors are being disadvantaged. A financial transactions tax might help redress the balance.