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In financial markets, high-frequency trading (HFT) is a type of algorithmic trading characterized by high speeds, high turnover rates, and high order-to-trade ratios that leverages high-frequency financial data and electronic trading tools. While there is no single definition of HFT, among its key attributes are highly sophisticated algorithms, co-location, and very short-term investment horizons. HFT can be viewed as a primary form of algorithmic trading in finance. Specifically, it is the use of sophisticated technological tools and computer algorithms to rapidly trade securities. HFT uses proprietary trading strategies carried out by computers to move in and out of positions in seconds or fractions of a second. Aldridge and Krawciw, 2017 estimate that in 2016 HFT on average initiated 10-40% of trading volume in equities, and 10-15% of volume in foreign exchange and commodities. Intraday, however, proportion of HFT may vary from 0% to 100% of short-term trading volume. Previous estimates reporting that HFT accounted for 60-73% of all US equity trading volume, with that number falling to approximately 50% in 2012 were highly inaccurate speculative guesses. High-frequency traders move in and out of short-term positions at high volumes and high speeds aiming to capture sometimes a fraction of a cent in profit on every trade. HFT firms do not consume significant amounts of capital, accumulate positions or hold their portfolios overnight. As a result, HFT has a potential Sharpe ratio (a measure of reward to risk) tens of times higher than traditional buy-and-hold strategies. High-frequency traders typically compete against other HFTs, rather than long-term investors. HFT firms make up the low margins with incredibly high volumes of trades, frequently numbering in the millions.
A substantial body of research argues that HFT and electronic trading pose new types of challenges to the financial system. Algorithmic and high-frequency traders were both found to have contributed to volatility in the Flash Crash of May 6, 2010, when high-frequency liquidity providers rapidly withdrew from the market. Several European countries have proposed curtailing or banning HFT due to concerns about volatility.
Advanced computerized trading platforms and market gateways are becoming standard tools of most types of traders, including high-frequency traders. Broker-dealers now compete on routing order flow directly, in the fastest and most efficient manner, to the line handler where it undergoes a strict set of risk filters before hitting the execution venue(s). Ultra-low latency direct market access (ULLDMA) is a hot topic amongst brokers and technology vendors such as Goldman Sachs, Credit Suisse, and UBS. Typically, ULLDMA systems can currently handle high amounts of volume and boast round-trip order execution speeds (from hitting “transmit order” to receiving an acknowledgment) of 10 milliseconds or less.
Such performance is achieved with the use of hardware acceleration or even full-hardware processing of incoming market data, in association with high-speed communication protocols, such as 10 Gigabit Ethernet or PCI Express. More specifically, some companies provide full-hardware appliances based on FPGA technology to obtain sub-microsecond end-to-end market data processing.
Buy side traders made efforts to curb predatory HFT strategies. Brad Katsuyama, co-founder of the IEX, led a team that implemented THOR, a securities order-management system that splits large orders into smaller sub-orders that arrive at the same time to all the exchanges through the use of intentional delays. This largely prevents information leakage in the propagation of orders that high-speed traders can take advantage of. In 2016, after having with Intercontinental Exchange Inc. and others failed to prevent SEC approval of IEX’s launch and having failed to sue as it had threatened to do over the SEC approval, Nasdaq launched a ‘speed bump’ product of its own to compete with IEX. According to Nasdaq CEO Robert Greifeld “the regulator shouldn’t have approved IEX without changing the rules that required quotes to be immediately visible”.
Michael Monroe Lewis (born October 15, 1960) is an American non-fiction author and financial journalist. His bestselling books include Liar’s Poker (1989), The New New Thing (2000), Moneyball: The Art of Winning an Unfair Game (2003), The Blind Side: Evolution of a Game (2006), Panic (2008), Home Game: An Accidental Guide to Fatherhood (2009), The Big Short: Inside the Doomsday Machine (2010), Boomerang: Travels in the New Third World (2011) and Flash Boys (2014). He has also been a contributing editor to Vanity Fair since 2009. His most recent book is called The Undoing Project.
Image By Michael Ivanov (tug) [CC BY 2.0 (http://creativecommons.org/licenses/by/2.0)], via Wikimedia Commons
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