How Trading Speed Can Affect Volatility and Liquidity

# Discrete Trading to reduce speculation


# Discrete Trading to reduce speculation












I recently read a paper by Terje Lensberg (2014) "Costs and benefits of financial regulation: Short-selling bans and transaction taxes" where he analyzed the effects of financial regulation (short selling bans, transaction taxes, ban of all leveraged products) on trading activity. In all cases you will find that good liquidity comes at the cost of high short-term volatility and therefore is best under the current regulatory regime.

My question refers to an idea from the Austrian economist Stephan Schulmeister. He once mentioned that implementing trading in two-hour cycles (no high-frequency trading anymore) would lead to better analysis of companies because traders would focus more on fundamental data than on trends and speculative material. He was also one of the first who supported transaction taxes.

I personally do not see how his idea would help to improve financial markets, do you have any idea?

## Answer by lehalle (score 1)

https://quant.stackexchange.com/a/77799

Slowing down markets is not a very recent idea; for archeological interest, I recommend:

- Budish, Eric, Peter Cramton, and John Shim. "The high-frequency trading arms race: Frequent batch auctions as a market design response" The Quarterly Journal of Economics 130, no. 4 (2015): 1547-1621 (video is available on a 2015 UCLA conference)

- Fricke, Daniel, and Austin Gerig. "Too fast or too slow? Determining the optimal speed of financial markets" Quantitative Finance 18, no. 4 (2018): 519-532.

The basic argument is the following: if you allow to trade at a frequency that is faster than the natural frequency of information issued on the tradable instrument, you may face an increase of useless volatility. Remember that in essence, we should perceive volatility as

- being good when it reflects the incorporation of information in prices (the price moves for a "good reason")

- being bad when it stems from illiquidity oscillations.

For fans of Market Impact: the first effect corresponds to permanent market impact and the second to temporary market impact.

This is an abstract view; in practice how do you know the speed at which information form prices?

- you have pure idiosyncratic effect: f.i. a company issues a new patent.

- you have sectorial effect: f.i. people are no more going to movie theatres and watch movies on platforms.

- you have correlation effects: f.i. company A and company B have the same suppliers, even if they are not in the same sector or industry.

- you have geopolitical effects: f.i. because of terrorist bombings shipping companies have to use another route.

Thus it seems difficult to know why is the proper frequency (even if the idea is seducing). They are a few elements that we can conclude by basic reasoning, like the fact that FX should trade more frequently than most companies, since almost any existing information has an influence on the relative strength of two currencies.

To conclude, let me reformulate my answer in terms of liquidity risk: what is the risk you face of holding a specific asset during 5 minutes and not being able to trade it? This is a (il)liquidity risk. Fundamental analysts' recommendations will be followed only if this risk is perceived as "small enough". And if we wait to get information to open trading, all market participants will be in the same direction, hence the asset will be very illiquid and mis-priced... Continuous trading appears to be a good option, or at least the best of all options we have in a realistic world.