In March 2023, the Dutch Authority for the Financial Markets (Autoriteit Financiële Markten, the AFM) published its latest issue of Market Watch, a periodical newsletter on current topics and developments in the capital markets. This issue of Market Watch focuses on algorithmic trading, a topic that the AFM has been particularly focussed on recently. The Market Watch sets out the terminology related to algorithmic trading, provides insight on algorithmic trading on the Dutch capital markets and describes the benefits and risks associated with algorithmic trading.
Among other things, the AFM explains the difference between execution algorithms and trading algorithms. An execution algorithm executes an order, but does not take the trading decision itself, whereas a trading algorithm can be programmed to take this decision. A term that should be distinguished from these algorithms, but that is associated with algorithmic trading, is High Frequency Trading (HFT), which concerns a technique whereby a large number of orders is executed extremely fast.
The AFM also observes that about 75% of transactions taking place on Dutch trading venues are algorithmic trades. The majority of these trades are carried out by non-Dutch firms, mostly those based in Germany, Ireland, France, the United Kingdom and Spain. Such firms include (investment) banks, proprietary firms and brokers.
In addition, the AFM identifies that on the one hand, algorithmic trading, by reducing the spreads of financial instruments, has made it easier and cheaper for investors to buy and sell financial instruments, while preventing the occurrence of human errors. On the other hand, algorithmic trading is associated with certain risks. For example, firms may not be able to control or explain the behaviour of algorithms developed by them and to ensure that these algorithms are orderly and behave as intended. Trading algorithms may (unintentionally) learn how to manipulate the market and may affect the market quality when interacting with other algorithms.
The AFM concludes that algorithmic trading has been rapidly developing. This will be closely monitored by the AFM, in cooperation with ESMA, other supervisory authorities, scientist and market participants. The Market Watch is available here.