High Frequency Trading and Dark Pools


What is high frequency trading (“HFT”)?

HFT firms seek to make a profit in financial markets (such as markets for stocks, futures, fixed income and forex) in a variety of different ways, all of which depend largely upon them being quicker than other market participants.

One of the most common methods adopted by HFT firms is to profit from the (often tiny) price movements caused by large trades placed by institutional investors. For example, if a pension fund sells a million shares of a certain stock, the price of that stock often dips slightly, before (usually) returning to a more normal price trend. HFT firms will buy this stock on the dip, and then attempt to sell the shares a few moments later once the price has ‘normalised’ at the previous higher level. Conversely, if a pension fund buys a million shares, the price of that stock will likely increase slightly before normalising at the previous lower value. A high frequency trader will seek to short-sell this stock, looking to close their position at a profit.

HFT firms are also able to take advantage of minuscule price differentials between markets which result from delays in transmission (for example brief instances where a futures contract can be sold for more than the price of the stocks that comprise it). They employ sophisticated computer programs that can spot anomalies, and act faster than the relevant exchanges to turn a profit, trading in a matter of micro seconds.

HFT is an area under increasing scrutiny, largely due to fears that the activity may pose a substantial threat to financial markets. Those fears appear to be well-founded, with HFT being blamed for the “flash crash” of 2010, where 10% of the value of US stock markets was lost in 36 minutes, and the later extreme fall on 24 August 2015. HFT firms have also been accused of contributing to a 28% spike in the Swiss franc in January 2015 and a collapse in US government bond yields in five minutes in October 2014.

HFT is not only dangerous to financial markets in a macro sense; it is also possible that the activity could cause significant damage to investors. This danger is particularly acute in the context of trading platforms known as ‘dark pools’.

What are Dark Pools?

Dark pools are private forums for trading securities and are not accessible by the general investing public. They are called dark pools because of their complete lack of transparency and regulation. Such murky waters have become prime hunting ground for more predatory HFT firms, and the operators of such exchanges have been accused of various wrongdoings, including:

  • i. actively seeking to attract HFT traders to dark pools by affording them advantages over other market participants, contrary to their claims to other participants that special safeguards had been effected to protect them from predatory HFT;
  • ii. providing misleading marketing materials to prospective dark pool participants, claiming for example that a “liquidity profiling” service would be provided to analyse each interaction in the dark pool in an attempt to reduce the level of predatory trading; and
  • iii. disclosing sensitive and detailed information to HFT firms in order to encourage their involvement in dark pools, including trade information belonging to other participants.

This conduct can result in damage for individual dark pool participants, who may be able to seek redress in the courts. For an in-depth analysis of the legal options open to such participants, please click here.

Carter-Ruck’s expertise in financial disputes, and dispute resolution more broadly, coupled with its understanding of the complex issues at play, places the firm in an ideal position to assist clients who have suffered loss as a result of misconduct by dark pool operators, or indeed as a result of predatory high frequency trading more generally.

For further information please contact Charles Enderby Smith and Persephone Bridgman Baker.


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