Regulations May Increase Risk of Flash Crash, Traders Says

A political drive to impose new regulations and rules at stock exchanges at a breakneck pace in the aftermath of another incident similar to the “flash crash” could actually increase risks in the financial system, according to hedge fund managers. They also claim that the politicians have no idea of how the financial markets work.

“What is new is technology. We need to understand it and we have to work with it.”

Michael Levas

“With a rush to bring new rules, you bring more layers of complexity, which in turn creates more risks. I would be very scared of a rush to add more layers of complexity to the markets because all they are doing is increasing the risk of something bad happening again,” says hedge fund manager Nick Nielsen at Deutsche Marshall Wace in London.

“I am a bit scared to see what the public response would be if that did happen again. There could be some pretty aggressive regulation coming very quickly, similar to what happened when all of the bank stocks were getting hammered in 2008,” Nielsen says.

Fractions of a Cent, Millions of Times

In Nielsen’s opinion is the current form of high-frequency trading (HFT“essentially a casino.”

“They make a lot of bets and they lose a lot of bets. But they happen to win more than they lose,” he says.

Peter Nabicht, chief technology officer at Allston Trading, a Chicago-based trading firm, also agreed that the casino analogy had some validity.

“Casinos make very small amounts on each bet and HFT firms do the same thing,” he says.

At the moment HFT accounts for 54 percent of equity trading in the US and 34 percent of equity trading in Europe, according to Tabb Group, a US-based financial technology consultancy firm.

Politicians Have “No Idea” About Trading

Nabicht and Nielsen agreed that the increasing grip HFT has on the financial markets formed part of an evolution of the financial markets towards increasingly electronic and automated trading strategies.

Michael Levas, founder and chief investment officer at Olympian Capital Management, a proprietary trading firm based in Florida, called for regulators and market participants to embrace the new trading technology shaping the trajectory of the financial markets.

”What is happening in the market place is nothing new,” he says.

“What is new is technology. We need to understand it and we have to work with it. That is the only way that we are going to be able to fix all the inconsistencies which are prevalent in the market place.”

Levas attacked politicians in Europe such as French Finance Minister Christine Lagarde for having “no idea” what it is like to work in the financial markets.

On that particular issue, I belive the hedge fund managers are right.

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