I was surfing information today when I came across a small but very interesting piece – this in the NYT by Graham Bowley titled, “Clamping Down on High-Speed Stock Trade” (October 9, 2011).

The problem – computerized high-frequency traders – and the capacity for these traders to make market swings  in global markets much worse.  Regulators it seems are playing catch up.

What is the impact, according to Graham Bowley:

High-frequency trading took off in the middle of the last decade when regulatory reforms encouraged exchanges to switch from floor-based trading to electronic.  As computers took over, daily turnover of stocks rose to 8 billion shares in the United States from 6 billion in 2007, according to BATS Global Markets. The trading, done by independent firms or on special desks inside big Wall Street banks, now accounts for two of every three stock market trades in America.

Now several academic studies have shown that high-frequency trading tends to reduce price volatility on normal trading days.  Well then no problem.  No, unfortunately it doesn’t seem t work as well when you have abnormal nail-biting stock trading days and some traders employ questionable practices.  In particular one practice called layering is a technique that involves issuing and then cancelling orders that the traders  never intended to execute.  Pension funds and ordinary investors have argued that such practice makes trading by longer term investors more difficult and has raised questions of fairness by many.

The great fear among regulators – now taking greater notice – of these high-frequency traers and their practices is:

Perhaps regulators’ biggest worry is over the unknown dynamics of the computerized stock market world that the firms are part of – and the risk that that at any moment it could spin out of control.  Some regulators fear that the sudden market dive on May 6, 2010, when prices dropped by 700 points in minutes recovered just as abruptly, was a warning of the potential problems to come.  Just last week, the briader market fell throughout Tuesday’s session before shooting up 4 percent in the last hour, raising questions on what was really behind it.

Regulators are now on it thinking about international regulation.  And in fact the International Organization of Securities Commission (IOSC) is preparing a report for G20 Finance Ministers on possible market abuse from technological development.  Another stroke for global financial regulation.