High-frequency trading

The high-frequency trading firms are coming for you!

 

You may have heard of the phrase high-frequency trading, but do you know what it actually entails?

 High-frequency trading firms are an integral part of the marketplace and trade in microseconds or even nanoseconds – now that’s fast! This brief guide will explain what high-frequency trading is, as well as its benefits and downsides.

 

Introduction

Automated stock trading systems have now become a core part of many exchanges. In addition to traditional brokers, electronic market makers and computerized algorithmic traders make up a large chunk of business on Wall Street.

Some report that these high-frequency trading (HFT) firms account for 50 percent or more of activity on all major exchanges in U.S. markets.

 Read about how these professionals are revolutionizing investment practices and learn how they work below

 

What is high-frequency trading?

High-frequency trading is a subcategory of algorithmic trading characterized by high turnover and high order-to-trade ratios.

 In general, a relatively small number of individuals or organizations place very large numbers of orders at low price levels (many trades per day) that are immediately executed or rejected in favor of pursuing another strategy.

 One major difference between high-frequency traders and other traders is that HFTs co-locate their computers as close as possible to an exchange's matching engine to ensure minimal latency (delay).

 Another distinguishing feature of some HFTs' activities is blockage, which occurs when a broker intentionally delays sending information to market centers.

 

Benefits of HFT

A lot of retail investors have a negative view of high-frequency trading (HFT) because it has been in the news so much over recent years. They associate HFT with problems like flash crashes, and events that seem unfair and at odds with what retail investors know about market efficiency.

 However, there are also very real benefits that HFT brings to markets that everyone can enjoy. Here's a quick rundown of what some of these benefits are:

 More liquidity in securities markets due to increased volumes; cheaper transaction costs as HFT has encouraged competition amongst exchanges; and increased transparency due to new technologies like data aggregation platforms being used by all levels of participants in capital markets.

 

Is HFT legal?

In order to understand why HFT firms want in on algorithmic trading, it’s important to get an understanding of what HFT is and how it works.

The entire premise of HFT is based on arbitrage; using advanced computer systems and complex algorithms to discover pricing discrepancies across markets and then act accordingly to make a profit.

 To keep things legal, HFT uses a system called latency arbitrage, which allows traders to only buy or sell assets after accounting for the time it takes information about those assets to reach other exchanges.

 The lower latency between exchanges (seconds instead of milliseconds), however, has led regulators in Europe and Asia to decide that even latency-arbitrage strategies may not be fair game.

 

Impact on individual investors

According to some estimates, high-frequency traders (HFTs) execute as much as 60% of all trades on U.S. markets and sometimes own up to 90% of all outstanding shares at certain times in specific companies.

The impact on individual investors? According to another estimate, your portfolio could be worth $100 billion less by 2020 if HFTs have their way—and there's not a thing you can do about it. The reality is that HFTs don't take money from retail investors but simply capitalize on price inefficiencies over which most investors have no control or knowledge: The mere existence of an HFT presence raises average market prices and reduces opportunity.

 

Impact on the market in general

It's almost as if HFTs don't exist. That is to say, people who aren't on Wall Street probably don't know what a high-frequency trader is.

 (If you do know about them, and have an opinion one way or another, please go ahead and leave it in the comments.) Chances are that most Americans will never encounter one in their daily lives; they're just not visible enough.

Slate Magazine High-Frequency Trading Firms Are Not Welcome: The idea of having computers making trades at lightning speed without human intervention may seem like a good thing but there are still many questions to be answered before we can determine whether or not high-frequency trading is beneficial.

 As of right now, there has been no proof showing that these types of transactions actually help anyone besides those doing it. High-Frequency Trading Firms are taking money from investors by making small profits off every trade made.

 

Rebuttal from HFTs

HFT is a methodology and set of technologies in which common stock orders are at high frequency (sometimes measured in milliseconds) by specialized computer systems.

These trades can occur at speeds that outpace most human traders and they can be placed through several different marketplaces.

The number of HFT firms has increased rapidly since 2008, but the amount of revenue generated by these firms has dropped off due to several factors including decimalization (addition of a decimal place to securities prices).

 Opponents point out that HFTs often use technology that gives them an unfair advantage over traditional investors who trade through human involvement. Instead, HFT makes markets more efficient because orders flow more quickly throughout global networks.

 

Rebuttal from experts against HFTS.

HFTs have proven to harm price discovery in multiple ways, including front running and quote stuffing.

 They have made it difficult to buy and sell stocks and bonds, particularly in illiquid market segments, due to rapid changes in prices that prevent investors from being able to execute their orders at predictable prices.

 HFTs' use of co-location facilities gives them an advantage over other market participants; they also may seek information or trade ahead of it becoming available to others.

Conclusion

The markets have taken a big step toward becoming more like a slot machines and less like an auction. The people who control these machines will get very rich in our current market structures. Is that really what we want?

 We need to demand that regulators start looking at where high-frequency traders make their money because they’re being allowed to use unfair advantages right now.

 If high-frequency traders must follow simple rules, maybe it won’t be worth it for these firms to turn our financial markets into gambling casinos. It’s time we took control of Wall Street once again...instead of letting it dictate how we invest our future.