Our Head of Equities, Stephen Dover, takes a look at what’s driving growth in high-frequency trading. He also explains why the algorithms behind the trading can lead to bouts of increased market volatility that may create opportunities for long-term investors.

Over the past 10 years, the abundance of relatively cheap computing power has led to a rise in the use of algorithms to perform high-frequency trading (HFT). These algorithms often process millions of pieces of data per second and make rapid trades on their own, without human input or oversight. This has transformed the way trades are made and executed.

While the pros and cons of HFT algorithms may be debatable, the growth in their use has unequivocally transformed the entire US equity market. HFT has accounted for about half of US stock market trading volume on an annual basis since the global financial crisis (GFC) a decade ago. This explosive growth has led some market commentators to conclude that HFT could contribute to the next market meltdown or at least lead to increased volatility.

Is High-Frequency Trading Responsible for Market Swings?

In our view, HFT plays a role in market meltdowns or melt-ups, which could be exacerbated when stocks or markets have low levels of liquidity. The US equity market, as represented by the S&P 500 Liquidity Index, has moved more for each dollar traded in recent years than it did historically. Reduced market liquidity can lead to more volatility, especially if the HFT firms exit a stock or market quickly.