High Frequency Trading: An Ethical Dilemma

Molelo Seame

Professor Wilson

Business Ethics         

High Frequency Trading: An Ethical Dilemma

        High Frequency Trading is a technologically advanced finance tool that utilizes high powered computers and advanced mathematical algorithms to conduct and execute hundreds of thousands of stock, swap, and future transactions within an extremely short period of time. These computers scan markets and analyze trends within nanoseconds. This allows the parenting traders or firms using these tools to capitalize on second and minute variances in prices and execute massive quantities of trades before individuals without high frequency trading capabilities. Currently, only a small segment of the market has access to these technologies due to the extremely high cost. High frequency trading and the ethical questions it raises are very complicated and complex. Depending on who is asked, the rise of this form of financial trading could be positive or negative as it has various affects on the various stakeholders involved.

The stakeholders in this case include but are not limited to, large banks (who use HFT), investors, boutique brokers, regulators, quants, and the companies supplying the HFT technology. The three primary subjects we will examine further will be the, boutique brokers, large banks and the technology companies supplying the HFT technology.

The primary ethical issue that high frequency trading creates is that it establishes an unfair market for securities trading due to its lack of transparency and unequal access. Because of the extremely high costs, only large investment banks, hedge funds and other institutional investors are able to afford the technology used in high frequency trading. Ultimately, these are the only market players able to capitalize on the information provided by high frequency trading. Another ethical issue that high frequency traders raises is that these utilizing market players have the ability to manipulate markets by releasing information from their algorithms that jukes the market. Many individuals believe that high frequency trading is a facet and fair utilization of the free market system, while critics will go as far to say that it is essentially insider trading. Some of these critics are boutique brokers. Boutique brokers are small scale investment firms that lack the capital to uses high frequency trading and resort to traditional investment analysis. These firms make up a large portion of the market and are adversely affected by high frequency trading. Using rule utilitarianism, members of these small investment firms could argue that the rise of high frequency trading is detrimental because it does not produce the greatest amount of positive goods for the greatest amount of people. If the information provided by high frequency trading was disclosed to all investors, or if regulations were implemented to limit the advantages of high frequency trading, the relationship between small firms and high frequency traders would be less troubling.

 From the vantage point of large banks, and more specifically, the high frequency traders. They view themselves as resourceful investors in an open market system. Currently the Securities and Exchange Commission places no restrictions on high frequency trading, therefore, unless they commit a violation, they are within their right to use high frequency trading technologies. The large banks would employ right based ethics to defend their use of these technologies because they are not engaging in any illegal practice. Naturally then, this ethical argument is contingent on the large banks continuing to conduct legal trades under the use of these technologies. When illegal trades or tactics are used, such as market manipulation, high frequency trading becomes more ethically troubling. Someone who is negatively impacted by market manipulation, such as boutique firms, would cite a breach in Kantian ethics to the bank who duped them. They would likely argue that through market manipulation, the large banks treated the small firms and most other players in the market as a means to an end, through lies and deception. This is a clear violation of Kant’s categorical imperative, which states that it is immoral to use another human solely as a means to an end. This analysis further reiterates the complexity of the ethical issues surrounding high frequency trading.