Sudden events happen. You can think of dramatic events such as terrorist attacks or death of an important executive; but there's other information, such as the public announcement of a new product (e.g. 'Apple are making a new type of device!', perhaps rapidly followed by 'Google have just said they'll support it!') that also result in fast changes.
But, most importantly, the market price provides information that influences further decisions. Maybe I'm not an expert on oil prices, but I believe if it goes below $70 a barrel, its a signal that the world economy is slowing down, and I want to dump my Google stock, because I'm only willing to accept a certain level of risk in my personal investments.
The fact that I can see the price of the oil provides me with a signal (maybe noisy), derived from aggregated intelligence of other investors. This is a useful function.
Its completely legitimate to want to sell my Google stock in response to other market signals, and as quickly as possible, in response to the new information they provide.
The fundamental value of holding the Google stock, to me, has changed, fast, because of other information that's become available.
So fundamental business value can change fast, for a variety of reasons, and it can add value to be able to respond to quick changes quickly.
You rightly argue that a rapid change in perceived business value is possible and furthermore that it is in the interest of any given individual investor in performing very quick trades.
But your examples support relative gain, not absolute gain. Even after HFT, there will be some investors who get rid of the hot potato before others (or the opposite acquire an attractive stock). It's just that the one's who are the first to trade will have to pay more resources to access powerful technology. Situations like these arise in many non-cooperative games, like an arms race, where an improved technology leads to increased loss to both sides but is unavoidable unless there is a scope for cooperation via a treaty.
Furthermore, this leads to a systematic bias in favour of large investors and hedge funds who are the ones with resources sufficient to win the arms race.
Note, that after HFT, the market value synchronizes faster by a short interval of time. Maybe there is an argument that this leads to a large absolute gain in some form by the way it affects investors decisions, but I dont see how it does.
There has been relative gain by a very important class of investors: individual retail investors. If you trade individual stocks for your own account, you've seen a steady decrease in the amount of spread that you have to pay to get your order executed and you certainly shouldn't be deluding yourself by thinking that you are competing with high frequency/low latency traders or that they will be somehow disadvantaging your orders. The people who are at the root of these complaints are the buy side institutions who don't want to invest in technology to improve their order placement and the older exchanges who are either also trying to avoid investment or who are struggling to protect obsolete business models. If the various proposals to limit the rate of trading are enacted, then spreads will widen out even for the large buy side players (perhaps even by an amount larger than what HFT is currently costing them), and the only winners will be the entities that want to remain fat, dumb, and happily protected by regulators.
I just realized that I had a wrong idea about how HFT works. Though I am still not sure about how the pros and cons add up, your comment convinced me that it is more complicated than I thought.
HFT is a disruptive technology that has been the target of lots of FUD from entrenched institutions and politicians looking for a "scary" issue to flog. Most of the practitioners are fairly small (relative to other investment firms) and technology-focused. Unlike complex, bespoke derivatives and products such as CDOs, this aspect of the markets is fairly well regulated, with a focus on bringing transparency to pricing for individual investors, which is in stark contrast to the regulatory environment in Europe and Asia.
Perception of business value can change quickly. Actual business value itself does not tend to change so fast. Dumping your Google stock if oil drops below $70 per barrel is solely based on your own perception and your own trading rules. The value of Google's products remain the same. If a competitor releases a new device, that is based in human time.
Does it make a difference if you sell at 12.01pm after a competitor's product announcement rather than 1pm? Right now, yes. Do I think it should? No.
The reason prices swing so quickly is because trades happen so quickly. If trading was slowed down, prices would not swing as quickly. The current situation reinforces a vicious cycle where the fastest trader has an advantage in the market.
Public share prices is a measure of how much the company is worth to people that buy shares not of how much value the company creates by selling their products. PepsiCo should be valued on how well they sell soft drink, not millisecond-by-millisecond analysis of unrelated issues.
There is no such thing as 'actual business value'. The very definition of value is based on perception; something of value is something people want. The closest concept I can think of to what you mean is "book value", which comes with its own set of drawbacks.
But what is 'actual business value'?
Lets say we are considering an oil company, which makes a profit from drilling oil. If oil rises in price, the company makes more profit. Surely, in a very real sense, the 'actual business value' of this company, depends on the price of oil?
Lets talk about PepsiCo.
The weather service detects a new hurricane forming off the coast of Florida, sending orange juice futures up.
At some discrete point in time, the weather forecast computer model spits out its results, and that information is on its way to becoming public, and there's going to be a fast change in the price of oranges, and hence the value of PepsiCo.
Here is an article, describing just such an event:
"
Orange juice futures hit a three-year high on Tuesday as speculators eyed the development of a Caribbean storm that meteorologists said had a chance of moving towards Florida.
Orange juice is a $20bn industry with prices affecting farmers in Florida and Brazil, processors, trading houses and bottlers such as Coca-Cola and PepsiCo.
"
http://www.ft.com/intl/cms/s/0/1831a65c-c5a8-11df-ab48-00144...
Now, lets look at Google. Lets say Google does better in a more buoyant economy, because they get more ads (maybe the opposite happens in real life; but its just an example). And the drop in the price of oil has given me information that others think the economy is tanking. Hasn't the 'actual business value' of Google changed, in a very real sense? And quickly?
You might argue, if you believed in a deterministic universe, that the value of Google hasn't changed - the economy was always going to tank, because the universe only plays out one way. But that's irrelevant, because we don't have access to such a model of the universe. What we have to make decisions on is the information we have access to, which can change suddenly, and which the markets do a good job of aggregating.
I'm not trying to argue for front running the trades in the market or anything like that. I'm just trying to argue that business value can change rapidly.
I think the reason prices change so quickly is because aggregated belief about the value of companies changes so quickly, and because our markets allow that change in aggregated belief to be quickly expressed.
If you slowed trading down, so that it happened hourly, as you might propose, what this would mean is that the price of PepsiCo is essentially out-of-date for an hour. I could no longer look at the price of PepsiCo on the market, and assume it was doing a reasonable job of aggregating the public information about the future prospects of PepsiCo - I'd have to imagine it was an hour out of date.
This would probably make the market less useful.
Why should we arbitrarily limit the efficiency of the markets? This just feels like some kind of luddite like fear of technology.
The markets have breaks in place to stop rapid crashes. The flash crash was caused by human placing a bad trade, quickly followed by the automated trading systems leaving the market.
Someone really has to make a much better case then this then pension funds being upset someone has detected their buy order and is driving up their purchase price.
The same reason we arbitrarily limit the gain of amplifiers, so the noise generated by flaws in the system doesn't keep feeding back until it drowns out the signal. Traders in capital markets are producing social value if they cause better decisions about allocating our resources, not the same decisions a fraction of a second sooner because of a greater misinvestment in network hardware. Front-running a trade that's already been decided on is just scalping.
be careful about the idea of clamping down on legal tax-paying businesses based on how much "social value" they are producing. It is very hard to judge that and it is subjective. One could argue,I am not arguing it but one could, that lots and lots of web startups produce very little social value. Should we ban them too?
Sudden events happen. You can think of dramatic events such as terrorist attacks or death of an important executive; but there's other information, such as the public announcement of a new product (e.g. 'Apple are making a new type of device!', perhaps rapidly followed by 'Google have just said they'll support it!') that also result in fast changes.
But, most importantly, the market price provides information that influences further decisions. Maybe I'm not an expert on oil prices, but I believe if it goes below $70 a barrel, its a signal that the world economy is slowing down, and I want to dump my Google stock, because I'm only willing to accept a certain level of risk in my personal investments.
The fact that I can see the price of the oil provides me with a signal (maybe noisy), derived from aggregated intelligence of other investors. This is a useful function.
Its completely legitimate to want to sell my Google stock in response to other market signals, and as quickly as possible, in response to the new information they provide.
The fundamental value of holding the Google stock, to me, has changed, fast, because of other information that's become available.
So fundamental business value can change fast, for a variety of reasons, and it can add value to be able to respond to quick changes quickly.