Of Course We Shouldn't Ban Flash Trading

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Chris Hynes and Donald Luskin have penned a powerful defence of “flash trading” in today’s Wall Street Journal. The urge to regulate is misdirected, they argue. Flash trading isn’t something that empowers privileged special interests. It’s actually a populist move that allows ordinary traders to conduct the kind of operations that used to be the exclusive purview of the big boys on Wall Street.

From the Wall Street Journal:

What is flash trading? As pioneered by the electronic communications network Direct Edge, it is simply a way for one customer to query other customers to see if they will take the other side of a trade.

Let’s say that among all the exchanges, the highest bid for stock XYZ is 10, and the lowest offer is 10.5. Bob enters a flash order to buy 500 shares in between, at 10.25. This order exists in Direct Edge’s system for mere milliseconds, but in that time the high-speed computers of other participants might decide to sell Bob the 500 shares he wants to buy. So Bob gets a price better than the best offer, and the seller gets a price better than the best bid. If a trade can’t be executed, then Bob can try other markets.

In this example, because the flash trade comes in between the best bid and the best offer, it does not contribute to market volatility. Buyer and seller have entered into a trade in which they both feel they have achieved the best possible deal, or they wouldn’t have traded. And the flash order created an opportunity for new liquidity to enter the market.

Flash trading is like offering to sell your house to your neighbour before you officially put it into the real estate listings. For that matter, it’s just like what upstairs traders did in the pre-computer era: shopping an order before sending it to the exchange floor. We had no problem with this process, so why would we ban flash trading, which simply makes it more formal and produces an audit trail that the upstairs traders didn’t?

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