Home > Uncategorized > A simple proposal to kill high frequency trading in the stock market

A simple proposal to kill high frequency trading in the stock market

from Trond Andresen

Due to technological possiblities, success in stock market trading has increasingly become dependent on being at the front of a rat race in software, computing capacity and fast optical cable connections. While the firms whose stock is traded obviously do not change their prospects over time horizons shorter than days or even months, to win in the stock selling and buying game, today you have to act and react on a time scale of fractions of milliseconds. Automated high frequency trading (HFT) enables this. This race has now become so absurd that even the business press and financial regulators and pundits have become critical to it. One technical measure against HFT that has been implemented by a new stock exchange, IEX, is that all traffic go through a roll of cable (!) that delays the signals so much that HFT trading cannot profit parasitically from orders given to that exchange.

Here follows a simple proposal which does not depend on any changes to physical infrastructure, can be mandated by regulators and implemented easily at any exchange, and which enables not only the blocking of trading on millisecond scales, but can remove trading on any time scale that is considered too short. Being implemented as software, it also has the advantage that its parameters can be easily adjusted based on how the system performs. This solution does not presuppose any transaction fee, and it impacts small and big trade(r)s in the same way.

The proposal is inspired by the signal processing literature, more specifically the concept of a digital finite impulse response (“FIR”) filter, known in the wider community as a moving average filter. The FIR filter outputs a weighted average of a finite number of earlier inputs. The output becomes a time sequence that has the high frequency components attenuated, and it is slightly time delayed, where we define the delay as the half of time interval back to the oldest input used in the filter. The filter can be seen as a moving “window” that smooths the input signal. The time breadth T of this window is essential for how the filter works. The larger T is, the stronger smoothing of the input signal, equivalently: the stronger removal also of lower frequency components.

Let us construct an example to explain how the filter works. We choose the time window T = 4 minutes (firms’ prospects of course do not change much during that time interval either, but we don’t need to make the interval larger and ignite unnecessary quarrels with the regulation-hostile financial community, because T = 4 minutes is sufficient to eradicate HFT).

Running time is called t. At t = 0 agent A buys 4 shares from B at 100$ each. Time goes until t = T/2 = 2 minutes. The server then executes the final settlement of A’s and B’s trade, which occured 2 minutes earlier. This is done by checking all trades of the same stock within the filter’s time window, from t = -2 to t = 2. Assume for simplicity that within this interval only two other events occured (in the real world it would be a lot more, but this is no problem for a computer): agent C bought 8 shares for 90$ at t = -1.5, and agent D bought 2 shares for 110$ at t = 1. We don’t need to consider the exact times, only that the two events were inside the time window that has A/B’s trade in the center. The filter outputs an adjusted price for A and B:

(8 x 90 + 4 x 100 + 2 x 110) / 14 = 95.71 $

At t slightly more than 2, the stock exchange server settles the difference with A, in this case A is paid back 4 x (100 – 95.71) = 17.14$.  And B has to pay the stock exchange the same amount.

The stock exchange had to pay out a sum, and it thus needs a buffer for such operations. But this buffer will all the time be replenished; every payment out is mirrored by a payment in.

Such a moving average filter should make HFT – which is technically very expensive – unprofitable, and it will die out. It is also, as already mentioned, a tool that can be additionally used to discourage day traders who operate on a minutes time scale, simply by making the time window T larger.

Essentially, one is forcing a slight bit of solidarity on the agents doing the trading. The advantage of being first or an insider is slightly reduced, and those close after is correspondingly better off. Buying and selling the same stocks within short intervals become much less attractive. But long-term investors will be negligibly impacted by such a system. Therefore, one could say that the above described filter has a second effect: to reduce speculative trading without damaging other activity.


Trond Andresen <trond.andresen@itk.ntnu.no>
The Norwegian University of Science and Technology
Faculty of Information Technology, Mathematics and Electrical Engineering
Department of Engineering Cybernetics
N-7491 Trondheim, NORWAY

  1. RS
    April 11, 2014 at 1:04 pm

    If you go to an ATM in germany get EUR and your account is in SEK it is very useful if algo trading can supply your EUR bills in milliseconds, no risk no wait and better currency rate for you when you get the money. Similar electricity markets benefit greatly from HFT traders because elctricity actually moves very fast accross nations. In the case of electricity markets HFT can save many people very much money as electricity can be used more efficently. Finally the markets themselves don’t need to guarantee execution times faster than minutes, this would save cost on running a live market. There is no need to invent a complex scheme to make it costly to trade at high speed or use a big roll of cable to slow down transactions. Low cost markets built on nosql and sql technologies will never support the very HFT of HFT anyway and be a lot cheaper for everybody to trade on than markets such as NASDAQ.

  2. rddulin
    April 11, 2014 at 6:47 pm

    A much better idea would be to have a transaction tax of perhaps 3% that applies to every transaction in the economy. Easy to collect, virtually eliminates market manipulation by Soros type “Power Traders” eliminates most other taxes with their associated special interest groups and is fair. Accommodates internet sales and international sales in a fair and efficient way.
    Why should a common laborer have to pay income ,property and sales tax on his meager transactions and the financial parasites get to use the nations money for free?

  3. Claude Hilliger
    April 12, 2014 at 5:14 am

    An even simpler proposal: It should not be difficult for brokers, or for the exchanges themselves, to program their computers so as to introduce a minimum delay between receipt of an order and its implementation. This minimum delay could be specified by the regulator. I would set this delay not in seconds, or minutes, but at a full day! This would also eliminate day trading,which equally serves no social purpose.
    Discussions of financial reform too often do not refer to the social function of finance and how that function can best be implemented. That function is to efficientl transfer funds from savings to investments in the real economy, i.e. in plants and equipmen, infrastructure, etc. The evaluation of such investments is not made on a split second basis.
    The specialized European electricity exchange, mentioned in the first commen, is an entirely different matter; no stocks or bonds are traded there.

  4. April 14, 2014 at 8:13 am

    Why not just impose a 1% tax on all trades? This is not only the simplest solution, it has the added advantage that it would provide billions to the government on an activity which has no socially redeeming value, and which actually has negative value in that it sows distrust in the markets and in the regulators (The SEC has recently been called a corrupt and bribed organization by a retiring top Administrator).
    Such a tax is consistent with other things we tax – like gas, alcohol, etc. – that actually sometimes DO have socially redeeming value, and it would have virtually no effect on the average trader except to make them more considerate of each trade and to eschew flipping in and out of stocks – empirically proven to be a good thing for the vast majority of investors in the long run.

    • rddulin
      April 14, 2014 at 3:03 pm

      Excellent idea. Key point: No socially redeeming value.

  1. No trackbacks yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.