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Subject 4. Impact of Algorithmic and High-Frequency Trading on the Security Markets

The broad market impact of algorithmic trading is largely positive.

The positive impacts include:

  • tighter bid-ask spreads,
  • lower transaction costs,
  • increases in liquidity, and
  • improved pricing efficiency.

The primary concerns regarding HFT are:

  • the potential for HFT to accentuate and accelerate market movements
  • the risk posed by an out-of-control algorithm
  • the ability of a trader to manipulate the market through spoofing or quote stuffing
  • the increased complexity of regulatory oversight, and
  • the impact of unequal access to information.

Practice Question 1

The following are concerns regarding HFT. Which one contributed to the loss of Knight Capital?

A. Fear of an unfair advantage
B. Gaming the market
C. Algorithms gone wild

Correct Answer: C

In the case of Knight Capital, an algorithm went out of control and submitted unanticipated orders.

Study notes from a previous year's CFA exam:

4. Impact of Algorithmic and High-Frequency Trading on the Security Markets