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OUR VIEW: Time to put the brakes on high-frequency stock trades
When stocks are cheap, they buy them and push the price up. When stocks are overpriced, they sell them and push the price back to where it should be. This helps all of us. We depend on these short-term traders to dampen volatility in the markets. Indeed, the glitch on May 6 was made worse when some of the high-frequency traders who normally stabilize trading stopped trading due to technical difficulties.
Other investors try to arbitrage differences in prices between related securities. For example, some traders use computers to watch the prices of exchange traded funds, popular investment vehicles that track stock market indices. When the price of an ETF falls below the prices of the stocks in its index, the arbitrageur buys the ETF and sells the underlying stocks. This pushes the price of the ETF closer to where it should be.
Thus, investors can be confident that the price of our ETFs will properly track their indices. Mutual funds that trade on behalf of retail investors also use computerized algorithms to execute their trades at lower cost.
No human technology is perfect. I warned the Securities and Exchange Commission in written testimony more than a year ago about the need for shock absorbers to protect us from glitches such as the one on May 6. The solution is not to prevent investors from using fast computers, but to speed up our supervision.
Our markets operate at computer speed, but the people who supervise them don't. We do not have computerized circuit breakers in the U.S. that react instantly when something goes wrong. We need a system similar to the German one in which trading is instantly halted for a short time when stock prices move too far, too fast.
James J. Angel is an associate professor of finance at the McDonough School of Business at Georgetown University.
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