tag:theconversation.com,2011:/nz/topics/dark-pools-3834/articlesDark pools – The Conversation2014-12-21T18:50:47Ztag:theconversation.com,2011:article/346592014-12-21T18:50:47Z2014-12-21T18:50:47ZDark pools don’t deserve shady reputation<p>Dark pools are growing in popularity and now account for more than 15% of total trading in some stock markets. But despite such trading being blamed by some commentators for everything from market instability to a decline in market liquidity, new research shows dark pools may not be as menacing as first thought.</p>
<p>Dark pools are alternative trading venues that do not communicate the trading interest of individual traders to the rest of the market prior to a trade. </p>
<p>Ten years ago, someone looking to buy 100 Vodafone shares would have little choice but to place an order on the London Stock Exchange (LSE). However, changes to securities trading rules around the world and advancements in technology have led to a proliferation of new trading venues that compete with traditional exchanges. Nowadays that same trader, or their broker, can transact on a host of different venues that offer an array of trading protocols and fee structures. </p>
<p>These changes have been so effective at encouraging competition between venues that the market share of the LSE has fallen from upwards of 95% to around 50% in the past decade. In the United States, the market share of the New York Stock Exchange has fallen from around 80% to around 25% over the same period. </p>
<p>One advantage of dark pools is that they facilitate trading in between the existing best bid and offer, thereby lowering the trading costs for the buyer and seller. They may also <a href="http://www.economist.com/blogs/schumpeter/2011/08/exchange-share-trading">help large institutions</a>, such as pension funds, prevent “front-running” of their orders that need to be executed over long periods of time. </p>
<p>Naturally regulators are wary of how the migration of trading away from ordinary “lit” venues to their less transparent competitors will affect stock markets. By the very nature of their trading rules, it is easier for traders to “hide their hand” in a dark venue and hinder the transmission of information throughout the market. </p>
<p>Drawing trading activity away from the main exchange may also make markets less stable and could make trading more expensive for traders who only have access to that venue, such as smaller institutions and retail investors.</p>
<h2>Do dark trades make stock markets less stable?</h2>
<p>Using transaction data in 2012 from the Financial Conduct Authority, I <a href="https://sites.google.com/site/jamesbrugler/home/research/job-market-paper">investigated</a> the effect of dark trading on market stability. </p>
<p>This is measured in terms of liquidity, loosely defined as the ability to buy or sell shares without adversely affecting the price, and volatility on the LSE. Both liquidity and volatility have important implications for financial stability and for understanding who wins and loses in this new financial landscape. </p>
<p>The main challenge is to estimate this relationship while accounting for traders choosing when and where to trade in a strategic fashion. A crucial factor in making these decisions are expected transaction costs and liquidity on the main exchange. This “reverse causality” issue makes it impossible to understand how dark trading affects liquidity on the main exchange from looking just at the raw correlations between these variables. </p>
<p>To solve this problem, I exploited trading patterns of certain computer algorithms that are programmed to trade at regular, predictable intervals throughout the day, regardless of expected market conditions. Focusing on these predictable intervals circumvents the problem of reverse causality and allows us to understand the effects of dark trading at a high frequency. </p>
<p>At the levels occurring in the UK equity market in 2012, dark trading did not lead to a deterioration of liquidity on the LSE. Some measures of liquidity actually improved following dark trades, while others did not significantly respond one way or another. Dark trading also led to reduced price volatility compared with trades of similar size on the fully transparent main exchange. </p>
<p>These results suggest dark pools help to create new trading opportunities that otherwise would not exist. They also appear to be well integrated with other trading venues, a role that is filled by institutions trading actively across many venues simultaneously. </p>
<p>There are a number of important caveats to these conclusions and the results should certainly not be interpreted as an unconditional endorsement of dark pools. </p>
<p>Perhaps most importantly, <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2183392">other research</a> has shown the negative impact of dark trading may only manifest when it accounts for relatively high fractions of total volume. </p>
<p>Nevertheless, regulators should keep an open mind about the potential benefits of these venues, especially in terms of competition and the associated reductions in trading costs, when considering new legislation.</p><img src="https://counter.theconversation.com/content/34659/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>James Brugler does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Dark pools are growing in popularity and now account for more than 15% of total trading in some stock markets. But despite such trading being blamed by some commentators for everything from market instability…James Brugler, Ph.D Student, Faculty of Economics, University of CambridgeLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/224442014-01-28T06:34:46Z2014-01-28T06:34:46ZExplainer: what are dark pools?<figure><img src="https://images.theconversation.com/files/39922/original/fg2f79m4-1390838248.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Where traders lurk.</span> <span class="attribution"><span class="source">byronv2</span></span></figcaption></figure><p>A <a href="http://www.bloomberg.com/news/2014-01-15/eu-lawmakers-seal-deal-on-financial-market-rules-overhaul.html">draft agreement</a> for an overhaul of EU securities trading regulation has now, eventually, been reached. Among <a href="https://theconversation.com/traders-can-no-longer-corner-corn-but-dont-expect-stable-prices-22367">other things</a>, some new rules have been designed to regulate the use of “dark pools”. </p>
<p>So what are these nefarious sounding trading venues, and where have they come from? As dark pool usage has <a href="http://qz.com/136710/the-volume-of-stocks-traded-in-secret-dark-pools-is-soaring-in-europe-what-could-go-wrong/">grown rapidly</a> in recent times, it is worth trying to understand whether this growth might have had a beneficial or a detrimental effect on the operation of securities markets (mainly for stocks and shares).</p>
<p>Roughly speaking a dark pool is a trading system that does not publish information on outstanding orders to buy or sell. Thus one can place an order to sell, say, but not advertise the fact that you wish to sell to the rest of the world. Then, periodically, buy and sell orders are matched with one another at a price that is usually derived from a “lit” (that is, not dark) market. After the trade is completed, the details (price and size) are published. Note, though, that there is no guarantee that if you submit an order to a dark pool, a trade will result (there will only be an execution if an order on the other side of the market arrives).</p>
<p>Thus, for example, a trader who wants to buy stock in Marks and Spencer might submit a buy order to a dark pool. Subsequently, if another trader has submitted a sell order for M&S to the pool, then the buyer’s order and seller’s order may be matched. If no such seller arrives then the buyer’s order goes unfilled but, importantly, no-one aside from the buyer knows that the order ever existed.</p>
<h2>Pros and cons</h2>
<p>Dark pools have some clear advantages, particularly for institutional traders. The fact that unexecuted orders are not visible to all market participants means that institutions can trade more stealthily, and thus hopefully more cheaply. For a big trader, keeping one’s intentions quiet is of paramount importance, especially in the modern world where high-frequency traders are quick to exploit predictable order flows from less nimble operators. Less visible trading translates into smaller impact on prices. Dark pool trades usually execute at better prices than those on lit markets and direct costs of trading on dark venues are often below those on lit venues. </p>
<p>There are, of course, also some drawbacks associated with dark trading. If big traders were to migrate to dark pools in sufficient numbers, then liquidity on lit markets such as the London Stock Exchange could suffer. Less trading on lit markets would likely lead to an increase in trading costs on those markets and also a reduction in market efficiency (as trading is a major part of the process through which information gets into prices).</p>
<p>There is also the issue that dark pools attract less well informed traders than lit markets. If dark pools siphon off uninformed trading, the lit markets could end up becoming dominated by informed traders and thus more “toxic”. In the end, regular lit markets would be both more expensive to trade and their prices less informative, and these are the prices which are then used to set terms of trade in dark markets.</p>
<h2>What’s the evidence?</h2>
<p>Recently, empirical evidence has been produced that allows one to evaluate some of these claims. Work on US markets suggests that, at low levels, dark pool activity might actually <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1630499">improve the quality of lit markets</a>, making them cheaper to trade, easier to trade big quantities on and less volatile. This effect is likely a benefit of increased competition between trading venues. </p>
<p>However, there have been suggestions from US and Australian data that when dark pool trading becomes relatively large (say more than 10% of overall volume), <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2183392">lit market quality suffers</a>. This is probably driven by successful dark pools attracting much of the uninformed trading activity, leaving lit markets populated by informed traders. Markets populated by informed traders are expensive to trade in.</p>
<p>This evidence suggests that EU regulators are correct to worry about dark trading to some extent. When dark trading accounts for too much of the activity in a particular stock, measures to rein it in are sensible. Some guide as to what “too much of the activity” is can be drawn from the research mentioned above. If use of dark markets remains steady, though, then little needs to be done other than to make sure that dark pools are really offering traders better prices than lit markets.</p>
<p>As it turns out, new EU trading regulations may affect dark pools through an indirect channel as well. The new rules also include provisions to limit high frequency trading, and if these limits were adopted this would probably reduce institutions’ incentives to seek to trade away from lit markets. As their predators will have been constrained, there may be a natural movement of trading activity back into the light and out of the dark.</p><img src="https://counter.theconversation.com/content/22444/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Richard Payne receives funding from the Leverhulme Trust.</span></em></p>A draft agreement for an overhaul of EU securities trading regulation has now, eventually, been reached. Among other things, some new rules have been designed to regulate the use of “dark pools”. So what…Richard Payne, Professor of Finance, Cass Business School, City, University of LondonLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/189052013-10-16T19:39:13Z2013-10-16T19:39:13ZExplainer: black markets, grey markets, and dark pools<figure><img src="https://images.theconversation.com/files/32635/original/q9qv6hw7-1381200636.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Trades on the 'grey markets' are becoming increasingly common in Australia.</span> <span class="attribution"><span class="source">flickr/zdenadel</span></span></figcaption></figure><p>There are a range of markets available to buyers and sellers that allow them to exchange goods and services. But whereas some markets are highly regulated, others are not regulated at all. </p>
<p>The sale of tobacco and alcohol is fairly heavily regulated, while there is little regulation governing the exchange of a second hand car between two individuals. </p>
<p>While there are organised markets that we all know and understand, lesser known avenues of trade such as “the black market”, “grey markets” and “dark pools” are all being increasingly relied upon by investors when buying or selling large blocks of financial securities. </p>
<h2>The Black Market</h2>
<p>A black market is one which operates illegally within its particular country. Black markets develop quickly to fulfil unmet needs wherever there is demand for a product but restricted supply. The black market in drugs is an obvious example of illegal trade. There is also a black market in tobacco; a product which is heavily taxed and regulated in Australia. </p>
<p>Black markets usually arise where trading is restricted in some sense. For example a black market could arise in order to avoid taxes or price controls, or it could arise to meet unmet demand for illegal products or services.</p>
<h2>Grey Markets</h2>
<p>Grey markets differ in that they are not illegal, but they are not authorised or controlled in the usual way. Goods and services may be acquired in one country and then legally brought into another country and sold. There may be no legal restriction on this activity but it does affect the profitability of those trading in the normal manner in the country where the good or service is sold.</p>
<p>One example of a grey market is the growth in online shopping that has occurred in Australia. Australian retailers have expressed considerable concern over the burgeoning online retail market, which has attracted the attention of shoppers due to its ability to provide cheaper, sometimes tax-free products. The popularity of this particular grey market is so strong that some of the most trenchant critics of online trading when it was first established, are now working <a href="http://www.smh.com.au/business/harvey-norman-takes-the-online-plunge-20111123-1nuj3.html">within this market</a>. Recent estimates suggest online sales had reached <a href="http://business.nab.com.au/tag/online-retail-sales-index/">$14.2 billion</a> for the year ended August 2013.</p>
<p>Grey markets exist outside of the usual market structures we have come to know. As a result these markets are often able to offer goods and services at lower prices, or offer a greater range, than what existing local markets can achieve.</p>
<p>A more recent example of a grey market in financial derivatives concerns the trading of Contracts For Difference (CFDs) related to Twitter shares.<a href="http://www.cnbc.com/id/101074151">Twitter’s Initial Public Offering</a> has only recently been announced. The social media giant will float its shares on the NASDAQ, with a possible initial listed value of $10 billion. Many investors were surprised by the poor performance of <a href="http://en.wikipedia.org/wiki/Initial_public_offering_of_Facebook">Facebook</a> when it listed, so there is some interest in CFDs relating to Twitter’s float. CFDs will provide a hedge against <a href="http://www.cnbc.com/id/101039323">unforeseen price movements</a> in Twitter’s IPO price as the IPO date approaches. While CFDs are banned in the US, it is possible for investors around the world to trade in these contracts via the web.</p>
<p>In terms of technology markets, a grey market for iPhones has recently emerged in China. This grey market is driven by the movement of iPhones from Hong Kong to mainland China, given that iPhones were generally made available in Hong Kong well before they were released in mainland China. Furthermore, Hong Kong sourced iPhones tended to be sold at lower prices than those that were available to regular consumers in mainland China. The result was a booming demand for iPhones in Hong Kong, followed by the resale of these iPhones into the mainland Chinese market. In fact, the <a href="http://gadgets.ndtv.com/mobiles/news/early-china-iphone-launch-expected-to-thwart-multi-billion-dollar-grey-market-417114">iPhone grey market</a> has become such a key player in China’s technology sector that Apple was forced to launch the iPhone 5 in the US and China simultaneously. </p>
<h2>Dark Pools</h2>
<p>In the case of dark pools buyers and sellers with large bundles of financial securities to trade are aligned with one another to complete their trades quickly and at low cost. </p>
<p>This option has always been available to Australian investors in the form of off market trades, though <a href="https://www.moneysmart.gov.au/investing/shares/how-to-buy-and-sell-shares/dark-pools">dark pools</a> provide an alternative to the organised markets. This is particularly important for investors like large mutual funds or superannuation funds. Were these traders to push all their trades through organised securities exchanges, their trading costs would increase substantially because organised exchanges do not always have sufficient depth to deal with large trades. Prices can move dramatically when there are mismatches in supply and demand. </p>
<p>Dark pools are informal in the sense that buyers and sellers identify each other, either directly or through intermediaries, and execute large securities trades without going to an <a href="https://www.moneysmart.gov.au/investing/shares#invest">organised securities exchange</a> like the Australian Securities Exchange or the Chi-X market.</p><img src="https://counter.theconversation.com/content/18905/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Richard Heaney has received funding from ARC in the past.</span></em></p>There are a range of markets available to buyers and sellers that allow them to exchange goods and services. But whereas some markets are highly regulated, others are not regulated at all. The sale of…Richard Heaney, Winthrop Professor, The University of Western AustraliaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/127842013-03-18T02:43:32Z2013-03-18T02:43:32ZThe rise of the machines: High Frequency Trading and dark pools<figure><img src="https://images.theconversation.com/files/21339/original/rtv32n7r-1363563748.jpg?ixlib=rb-1.1.0&rect=14%2C7%2C974%2C564&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Are the algorithms used in high frequency trading a threat to the markets themselves? ASIC says the danger is "overstated" but the FBI and the SEC have joined forces.</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>In language that is more in keeping with hackers and crime syndicates, the Financial Times <a href="http://www.ft.com/intl/cms/s/0/11b81d74-85a4-11e2-9ee3-00144feabdc0.html#axzz2MjZ0v0xK">reported</a> last week that the FBI was going to assist securities regulators in the US to tackle “<a href="http://en.wikipedia.org/wiki/Dark_liquidity#Dark_pools">dark pools</a>” and <a href="http://en.wikipedia.org/wiki/High-frequency_trading">high frequency trading</a> abuses. Although it is not clear what the FBI’s qualifications are in the complicated area of market making or arbitrage trading, it is presumably their technical expertise they are bringing to the party as financial firms are rapidly outpacing the SEC in exploring new ways to make money with computers.</p>
<p>High frequency trading (HFT) refers to the practice of making trades using computer <a href="http://en.wikipedia.org/wiki/Algorithm">algorithms</a> that determine what stocks to buy or sell. The shares may only be owned for fractions of a second as the computer responds to both data from news feeds, social networks and other sources and also to the reactions of the market itself. HFT is one type of “<a href="http://en.wikipedia.org/wiki/Algorithmic_trading">algorithmic trading</a>” which refers to trading by computers that may, or not, involve human assistance.</p>
<p>This can give the financial firms the ability to carry out millions of transactions automatically, triggered from data sources that the computers are following. The overall number of stocks that are traded in this way is substantial and represents about 50% of the market in <a href="http://www.nytimes.com/2012/10/15/business/with-profits-dropping-high-speed-trading-cools-down.html?ref=highfrequencyalgorithmictrading">the US</a>. In Australia, the figure may be lower with <a href="http://www.smh.com.au/business/highfrequency-trading-rewriting-the-rule-book-20121026-28azm.html">one source</a> quoting 30% of the market trades being computer-driven.</p>
<p>HFT came to the public’s attention after the Dow Jones <a href="http://en.wikipedia.org/wiki/2010_Flash_Crash">experienced</a> a 9% drop over a 5-minute period in May 2010, which recovered 10 minutes later. Although the initial trigger for the crash was due to a computer error in which a mutual fund tried to sell $4.1 billion of futures contracts, HFT then kicked in and exacerbated the process first by automatically selling and then by switching off altogether as the market drop crossed a threshold. </p>
<p>Academics <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1686004&">studying</a> the phenomenon of “flash crashes” have found they are reasonably common and in most cases are due to HFT, hence the concern by market regulators to understand and control the practice.</p>
<p>The existence of dark pools is making the situation of high-frequency trading worse. Dark pools refer to the practice of making trades that are not disclosed to the public. This may be something that brokers arrange themselves or may be something offered by dark pool companies or indeed stock exchanges. Because large volumes of trades may be executed away from public scrutiny, information about these trades coupled with information from markets around the world creates an opportunity for computer algorithms to spot opportunities to make money from the differences in prices between these markets.</p>
<p>Underpinning all of this is a move by exchanges and finance companies to try and gain advantages by moving to ever faster computers, networks and sources of information. Even cables that connect exchanges in the US or across the Atlantic are being built to shave 1000s of a second off the transmission time between the exchanges. It has been <a href="http://www.motherjones.com/politics/2013/02/high-frequency-trading-danger-risk-wall-street">estimated</a> that one thousandth of a second of a speed advantage can make as much as $100 million a year difference in earnings.</p>
<p>Behind the hardware is software that is processing information so fast that the SEC is treating it as a form of insider trading because the computers have access to information that gives it an anti-competitive advantage.</p>
<p>Proponents of HFT are ready to quote the many advantages that it brings to the market. In particular there is the argument that HFT brings “liquidity” <a href="https://www.moneysmart.gov.au/investing/shares/how-to-buy-and-sell-shares/high-frequency-trading">to the market</a> by ensuring that the difference between the selling and buying price is minimised. However, this has been <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1686004&">disputed by others</a>.</p>
<p>In Australia, the Federal Government <a href="http://www.bloomberg.com/news/2013-03-12/high-frequency-trades-need-measured-rules-asic-s-medcraft-says.html">last year</a> ruled that all automated trading systems were required to have a “kill switch” by June 2014, to halt trading in the event of a malfunction. They also ruled that dark pools needed to offer a better price than public exchanges. The focus on “kill switches” has been described by one trading insider as being misguided however. </p>
<p>The Australian Securities and Investments Commission <a href="http://www.asic.gov.au/asic/asic.nsf/byHeadline/13-052MR%20ASIC%20reports%20on%20dark%20liquidity%20and%20high-frequency%20trading?opendocument">today reported</a> on the results of two taskforces set up last year to examine the impact of HFT and dark pools on the Australian market. They found that the concerns over HFT had “been overstated” but did state that dark pools would need further regulation.</p>
<p>Although there will always be a role for humans in trading, computers and computer algorithms will continue to play a significant part in how financial firms make money. With ever increasing amounts of data that are being factored into decisions at ever increasing speeds, humans are just not capable of making these decisions reliably. </p>
<p>The complexity of the software is such that it is almost impossible to know what the overall impact on financial markets is, let alone what it will be. Perhaps the constant speculation about the stock value of companies like Apple and Facebook makes more sense if they are seen as being driven not by announcements like Samsung’s new phone or new features in news feeds, but by millions of tiny bits of information seen only by computers.</p><img src="https://counter.theconversation.com/content/12784/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>David Glance does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>In language that is more in keeping with hackers and crime syndicates, the Financial Times reported last week that the FBI was going to assist securities regulators in the US to tackle “dark pools” and…David Glance, Director, Centre for Software Practice, The University of Western AustraliaLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/95722012-09-17T04:26:30Z2012-09-17T04:26:30ZCould high frequency trading lead to our own ‘flash crash’?<figure><img src="https://images.theconversation.com/files/15448/original/xhbrt3pd-1347585206.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">As high frequency trading and dark pools worry Australian regulators, can a market be too fluid? </span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>The dangers of massive high frequency trading are becoming increasingly clear in equity markets. Greg Medcraft, the chairman of corporate regulator ASIC, confirmed to a Federal parliamentary committee:</p>
<p>“Regulators around the world are very concerned about the systemic risk on high frequency trading. We have already had the flash crash, we have had Knight Capital, but there have been incidents in other major markets as well.”</p>
<p>His colleague, ASIC deputy commissioner Belinda Gibson, suggested algorithmic and high frequency trading is sometimes manipulative or illegal, but it is often simply predatory on other investors.</p>
<p>In response, ASIC is proposing mandatory computer “kill” switches that stop trades which appear to be out of control.</p>
<p>In addition, regulators are concerned about the increase of trading taking place in “dark pools”, and are encouraging trades back out on to open exchanges.</p>
<p>A recent discussion of this issue in the Australian Financial Review ironically juxtaposed David Gonski’s sage call for a long-term view of investment and University of Sydney’s Professor of Finance, Alex Frino’s acute explanation of the increasing prevalence of high-frequency trading (HFT), which starkly highlighted the complexities of contemporary finance markets.</p>
<p>The immense divide between the 20-year timeframe of fund managers to provide retirement benefits to the public, and the frantic high-velocity trading in which micro-seconds are critical, demands further investigation.</p>
<p>Firstly, there is a profound distinction between investing and trading. These are very different activities and deserve to be regulated, supervised and taxed in different ways.</p>
<p>The <a href="http://www.bis.gov.uk/assets/biscore/business-law/docs/k/12-917-kay-review-of-equity-markets-final-report">Kay Review of UK Equity Markets and Long-Term Decision Making</a> published in July analysed this distinction. High frequency traders are driven by short-term market trends, and turn their portfolios over rapidly. Underlying performance is of less interest than immediate opportunity. In contrast, investors intent on holding assets for the long-term will analyse a companies’ prospects and underlying performance.</p>
<p>Kay concludes: “Equity markets work effectively for the corporate sector when they encourage, and do not impede, decisions which enhances the long-term competitive capabilities of the business.” The concern is that the short-term emphasis of equity markets may have encouraged unproductive value extraction at the expense of sustainable value creation.</p>
<p>Advances in financial, computing and communications technologies have facilitated the dramatic reduction of the average holding period of equity: on the NYSE this has diminished from seven years in the 1950s to six months today. More worryingly, as much as 70% of trading volume on the NYSE is measured now in milliseconds, and other exchanges are similarly overwhelmed.</p>
<p>The more impact short-term traders have in the market, the more volatile prices will be as these become less rooted in the fundamentals of the value of corporations traded, as the Bank of England’s Andrew Haldane has <a href="http://www.bankofengland.co.uk/publications/Documents/speeches/2011/speech509.pdf">documented</a>.</p>
<p>Present financial wisdom, and the securities regulation that has been developed within the same paradigm, suggests there is no such thing as too much liquidity, too much volatility or too much trading, as Justin Fox, Harvard Business Review’s editorial director and Harvard Business School professor Jay Lorsch argue in the current issue of the HBR.</p>
<p>Yet this creates very hazardous financial seas in which to navigate any corporate vessel. <a href="http://hbr.org/1992/09/capital-disadvantage-americas-failing-capital-investment-system/ar/1">Michael E. Porter</a> once warned the US Council on Competitiveness of the problems for business created by a too fluid capital market.</p>
<p>More recently the consequences for corporate America were revealed by <a href="http://www.upjohninst.org/Publications/Titles/SustainableProsperityintheNewEconomy">Professor Bill Lazonick</a> of the University of Massachusetts in his barnstorming tour of Australia in July: US corporations have hoarded trillions of dollars, and they will only spend money on dividends, share buy backs and executive options – all designed to enhance their share price.</p>
<p>Disastrously, investment in innovation, product and skill development has <a href="http://www.finnov-fp7.eu/events/finnov-final-conference-2012">collapsed in US industry</a> (with the large corporation exceptions of Apple and Google). Last year the America had a US$60 billion trade deficit in high tech goods, according to the <a href="http://www.commerce.gov/sites/default/files/documents/2012/january/competes_010511_0.pdf">US Department of Commerce</a>.</p>
<p>Australian industry could be heading rapidly in the same direction. The optimistic forecast of the Prime Minister’s Manufacturing Task Force <a href="https://theconversation.com/the-blueprint-for-a-smarter-australia-starts-with-manufacturing-8900">published this month</a> will only be secured if patient capital is available.</p>
<p>Business innovation is fuelled by investment. Innovation trajectories are shaped not simply by new knowledge and technical capability, but the rates and criteria by which financial markets and institutions will allocate resources to innovative business enterprise.</p>
<p>As <a href="http://www.regnan.com/">Regnan</a> has observed, long term innovation and investment performance requires attention to more than short term financial metrics.</p><img src="https://counter.theconversation.com/content/9572/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Thomas Clarke does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The dangers of massive high frequency trading are becoming increasingly clear in equity markets. Greg Medcraft, the chairman of corporate regulator ASIC, confirmed to a Federal parliamentary committee…Thomas Clarke, Professor, Centre for Corporate Governance , University of Technology SydneyLicensed as Creative Commons – attribution, no derivatives.