High Frequency Trading, the SEC, and the Legacy of the Flash Crash

High-frequency trading (HFT) is a significant evolution in financial markets which, combined with the Flash Crash of May 6th 2010, has been the impetus for many calls for regulation in the United States. This paper addresses the question regulation in two ways. First, is a review of the literature on the effects of high-frequency trading on the equities markets. The conclusion drawn from this review is that high-frequency trading generally improves quality (HFT passivity) but carries the potential to have negative effects during times of abnormal market behaviour (HFT aggression). This is used to inform an evaluation schema for the various regulatory proposals. Second, this schema is applied to various types of proposals for the regulation of high-frequency trading. The conclusion of this paper is that order-submission restrictions based upon price range are the best tool for promoting passivity among high-frequency traders while limiting the potential for aggressive behaviour.