Enlarge image (© picture alliance / dpa) A new piece of draft legislation from the German government will attempt to rein in high-frequency trades, the sometimes risky stock-market transactions that run according to a computerized formula, buying and selling large amounts of assets in just seconds.

The finance ministry estimates that high-frequency trades account for 40 to 50 percent of the German stock market's total volume. The draft bill, cleared by Chancellor Angela Merkel's cabinet, would make high-frequency trades easier to track, require its traders to be more accountable and take steps to limit fallout if the high-tech systems running the trades run awry.

Basically, such trades begin as algorithms. These mathematical formulas then interpret data from the market, and generate subsequent investment positions based upon said data. Buying and selling from these investment positions then commences rapidly – up to thousands of times per day. And the positions themselves can change just as quickly, in split seconds, as new data arrives from the market.

That is to say, these are not long-term investments held over years and alternating infrequently – high-frequency trading is about small gain in a short time compiling over years. However, with such velocity, so too comes volatility. Some of the attendant dangers associated with it are extreme currency fluctuation, overloaded trading systems and the increased risk of malpractice or mistake.

The example most often employed to illustrate the potential danger of high-frequency trading is the flash crash of March 6, 2010, which saw the Dow Jones Industrial Average suddenly drop almost 1,000 points, its largest intraday points loss. While the cause of the sudden crash, which was mostly recovered in mere minutes, is a point of continued discussion, the US Securities and Exchange Commission and the Commodity Futures Trading Commission jointly issued a report in which high-frequency trades were said to contribute to the instability before the crash.

What's to be done

To steady these trades and shield the larger market from their potential turbulence, Germany is moving forward on a number of reforms. For instance, those who deal in high volumes of high-frequency trades will now be required to be licensed. In addition, assets traded by algorithms will now be expressly labeled and the exchanges managing high-frequency trades will have an emergency lever of sorts to shut them down if they malfunction. Finally, traders who transgress limits will be fined.

The draft bill also solidifies the role of the Federal Financial Supervisory Authority in matters of access to information and intervention, as well as precisely edifying what constitutes market manipulation among high-frequency traders.

The European Union has introduced similar legislation, which is currently being considered in Brussels. Germany's draft bill will now be discussed in both houses of parliament before it is approved or denied by the Bundestag.