In this blog post, we’ll examine how high-frequency trading (HFT) created instant profit opportunities and caused problems, focusing on the 2010 “Flash Crash” incident.
Event Overview
It was around 2:47:50 p.m. on May 6, 2010. The stock price of Accenture, a global consulting firm that typically traded around $40 per share, suddenly began to plummet. As if falling off a cliff, the stock price dropped to just 1 cent in a matter of seconds, leaving onlookers momentarily stunned. Soon, some investors recognized this situation as a once-in-a-lifetime opportunity. If they expected the stock price to quickly recover to its original level, buying at that moment could theoretically yield a return of up to 400,000%. It led people to imagine a scenario where investing just 10,000 won could result in enormous profits.
In fact, after the stock plummeted that day, some people rushed to place buy orders, but in many cases, the price rose again before their orders were executed, causing them to miss the opportunity. This phenomenon has since been called a “flash crash.” While the exact cause remains a subject of debate, computer-driven automated trading has been identified as a major contributing factor.
What is High-Frequency Trading (HFT)?
High-frequency trading is a technique that uses computer algorithms to buy and sell large volumes of stocks in a very short time—ranging from one-thousandth to one-ten-thousandth of a second. Since the system is programmed to automatically place buy or sell orders when predefined conditions are met, it can respond quickly to ultra-short-term price fluctuations that are difficult for humans to react to.
For example, if a condition such as “Buy as much Accenture stock as possible when the price hits 1 cent” is programmed in advance, the computer can immediately execute a large-scale purchase at that exact moment. In fact, there have been reports of some investment firms using high-frequency trading to generate very stable returns over the long term.
Why doesn’t everyone use high-frequency trading?
Although high-frequency trading offers the potential for very high returns, there are two main reasons why it isn’t easily accessible to everyone. The first is expertise. Designing high-frequency trading algorithms requires a deep understanding of the stock market and advanced programming skills. Since success depends on the algorithm’s efficiency, this field involves IT researchers with PhDs and market experts.
Second is physical infrastructure. To secure an edge measured in milliseconds, high-performance computers, fast internet connections, and facilities like “colocation”—where servers are placed near exchange servers—are required. High-frequency trading firms install expensive equipment near exchanges to transmit orders as quickly as possible.
Issues and Social Impact
While high-frequency trading brings substantial profits to some, it also creates various problems. If a single firm consistently generates profits regardless of market fluctuations, it can dampen the investment enthusiasm of retail investors, potentially leading to a decline in trading volume and a weakening of market liquidity. Furthermore, if many participants set similar conditions, automated bulk orders may flood the market simultaneously, causing sharp fluctuations in stock prices and potentially leading to price extremes.
Following the flash crash, high-frequency trading technology was identified as one of the primary causes of the incident, and attempts to artificially manipulate prices by abusing this technology have been raised as a concern. Consequently, discussions regarding the use and scope of this technology, as well as regulatory and ethical responsibilities, are ongoing.
As such, high-frequency trading is a double-edged sword. While the technology itself offers fleeting opportunities, institutional safeguards and responsible behavior on the part of users must be established to prevent the market instability and unfairness that can result.
If you hadn’t read this article, you might have missed such an opportunity. But now you understand what high-frequency trading is and how it simultaneously presents both opportunities and risks.
