Computer-based trading can have beneficial effects on liquidity, transaction costs and the efficiency of market prices, according to the Government’s chief scientific adviser, Sir John Beddington.
In a new report, Sir John sheds light on the technological advances that enable computer algorithms, rather than humans, to drive the high-speed stock trades that have transformed markets in recent years.
He concludes that the technology has had beneficial effects, notably: liquidity has improved, transaction costs have fallen for both retail and institutional traders, and market prices have become more efficient.
In addition, the study found no direct evidence that computer-based high frequency trading has increased volatility in financial markets, nor evidence to suggest it has led to a rise in market abuse.
However, in specific circumstances computer-based trading can lead to market instability and periodic illiquidity.
The report therefore recommends that policy-makers priorities measures to limit future market disturbances as follows:
Immediate evidence-based regulatory action – European authorities working together with practitioners and academics should assess and introduce ways to manage the adverse side-effects of computer-based trading and incentivise accident-avoiding practices and behaviour.
A larger role for standards – implementation of accurate, high resolution, synchronised timestamps should be considered as a key means for helping analysis of financial markets.
Better surveillance of financial markets – through the development of software for automated forensic analysis of adverse/extreme market events.
In the longer term more needs to be done to improve understanding of the effects of computer-based trading, such as unlocking the power of the scientific community to play its role in addressing the challenge of developing better evidence-based regulation.