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June 9, 2016

High Frequency Trading Yields Little Regulatory Attention

Whether we realize or not, the age of artificial intelligence is and has been an integral component in societal functions. Artificial intelligence (AI) has a lot of negative baggage associated with it; however, despite the portrayal in pop culture, AI has affected the way we work, live and play.

The ads that appear while browsing the internet, suggested songs on your Spotify home page, online assistants such as Apple’s Siri, or even facial recognition on your camera are all a forms of AI.

However, AI’s largest impact on American wallets and retirement savings – high-frequency trading (HFT) of stocks – goes largely unchecked by regulators.

Wall Street has implemented machine learning and high speed communications into HFT so that stocks are traded in milliseconds. HFT has become an efficient and effective means of trading. At its peak, HFT accounted for nearly 70 percent of all international and domestic equity trades in 2010.

The computers are programmed to do one thing: produce a profit. For this reason, HFT contributes to market volatility in periods of economic instability by quickly selling massive amounts of underperforming stock, accounting for massive drops in the New York Stock Exchange and NASDAQ.

There is currently no government legislation that specifically taxes these high-frequency trade transactions. The only country to impose any tax on HFT is Italy, but even their .02 percent tax per transaction would rarely apply to HFT as it limits the tax to transactions that take longer than a half second. The average HFT transaction takes just seven milliseconds, making it impervious to the Italy tax.

Tax legislation has moved slowly in the United States due to the complex nature of HFT. However, Democratic Presidential Candidates Hillary Clinton and Senator Bernie Sanders have both proposed a tax on HFT. Clinton’s “Wall Street Plan” seeks to heavily penalize Wall Street high-frequency traders.

With the likelihood increased regulation on the horizon of HFT, there is likely to be a decline in percentages of equity trades by HFT due to the nullification of incentives by legislation. Tax imposition and any form of regulation will stimulate a sharp decay in HFT use.

But, the heyday of HFT may already be behind us. The industry has already seen a decline in HFT usage to a little less than half of all equity trades. The profits from HFT have gone from $5 billion in 2010 to a measly $1 billion the last fiscal year.

This deterioration can be attributed to many factors. In 2010, the fragile post-2008 recession economy caused market volatility that saw stock price fluctuations that were so fast that people couldn’t react, but computers could. The 2010 recovery further provided computers the ability to generate super profits, but as the markets have settled the past couple of years, HFT has been rendered much less profitable.

If money is power, HFT is helping create winners and losers everyday. Yet, something so paramount to our future is, as of right now, so unregulated by government and unknown to the population.

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