High-frequency trading

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Terms

High-frequency trading (HFT) is a type of algorithmic trading in finance characterized by high speeds, high turnover rates, and high order-to-trade ratios that leverages high-frequency financial data and electronic trading tools.[1][2][3] While there is no single definition of HFT, among its key attributes are highly sophisticated algorithms, co-location, and very short-term investment horizons in trading securities.[4][5][6][7] HFT uses proprietary trading strategies carried out by computers to move in and out of positions in seconds or fractions of a second.[8]

In 2016, HFT on average initiated 10–40% of trading volume in equities, and 10–15% of volume in foreign exchange and commodities.[9] 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.[6] HFT firms do not consume significant amounts of capital, accumulate positions or hold their portfolios overnight.[10] 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.[11] High-frequency traders typically compete against other HFTs, rather than long-term investors.[10][12][13] 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.[5][14] 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.[5][13][14][15][16] Several European countries have proposed curtailing or banning HFT due to concerns about volatility.[17] Other complaints against HFT include the argument that some HFT firms scrape profits from investors when index funds rebalance their portfolios.[18][19][20]

  1. ^ Aldridge, Irene (2013), High-Frequency Trading: A Practical Guide to Algorithmic Strategies and Trading Systems, 2nd edition, Wiley, ISBN 978-1-118-34350-0
  2. ^ Lin, Tom C. W. "The New Financial Industry" (March 30, 2014). 65 Alabama Law Review 567 (2014); Temple University Legal Studies Research Paper No. 2014-11; SSRN 2417988.
  3. ^ *Conerly, Bill. "High Frequency Trading Explained Simply". Forbes. Retrieved 27 June 2016.
  4. ^ Lemke and Lins, "Soft Dollars and Other Trading Activities," § 2:31 (Thomson West, 2016–2017 ed.).
  5. ^ a b c "Regulatory Issues Raised by the Impact of Technological Changes on Market Integrity and Efficiency" (PDF), IOSCO Technical Committee, July 2011, retrieved 2011-07-12
  6. ^ a b Aldridge, Irene (July 8, 2010). "What is High Frequency Trading, After All?". Huffington Post. Retrieved August 15, 2010.
  7. ^ "Advances in High Frequency Strategies", Complutense University Doctoral Thesis (published), December 2011, archived from the original on 2015-09-30, retrieved 2012-01-08
  8. ^ "Stock Traders Find Speed Pays, in Milliseconds". The New York Times. 24 July 2009. Retrieved 27 June 2016.
  9. ^ Aldridge, I., Krawciw, S., 2017. Real-Time Risk: What Investors Should Know About Fintech, High-Frequency Trading and Flash Crashes. Hoboken: Wiley. ISBN 978-1-119-31896-5.
  10. ^ a b "Trade Worx / SEC letters" (PDF). April 21, 2010. Retrieved September 10, 2010.
  11. ^ Aldridge, Irene (July 26, 2010). "How profitable is high frequency trading". Huffington Post.
  12. ^ Easley, David; Marcos Lopez de Prado; Maureen O'Hara (October 2010), "The Microstructure of the 'Flash Crash': Flow Toxicity, Liquidity Crashes and the Probability of Informed Trading", Journal of Portfolio Management, SSRN 1695041
  13. ^ a b Vuorenmaa, Tommi; Wang, Liang (October 2013), "An Agent-Based Model of the Flash Crash of May 6, 2010, with Policy Implications", VALO Research and University of Helsinki, SSRN 2336772
  14. ^ a b How to keep markets safe in the era of high-speed trading (PDF)
  15. ^ Cite error: The named reference WSJ1 was invoked but never defined (see the help page).
  16. ^ Jones, Huw (July 7, 2011). "Ultra fast trading needs curbs -global regulators". Reuters. Archived from the original on January 28, 2016. Retrieved July 12, 2011.
  17. ^ Ross, Alice K; Will Fitzgibbon; Nick Mathiason (16 September 2012). "Britain opposes MEPs seeking ban on high-frequency trading. UK fighting efforts to curb high-risk, volatile system, with industry lobby dominating advice given to Treasury". The Guardian. Retrieved 2 January 2015.
  18. ^ Amery, Paul (November 11, 2010). "Know Your Enemy". Retrieved 26 March 2013.
  19. ^ Petajisto, Antti (2011). "The index premium and its hidden cost for index funds" (PDF). Journal of Empirical Finance. 18 (2): 271–288. doi:10.1016/j.jempfin.2010.10.002. Retrieved March 26, 2013.
  20. ^ Rekenthaler, John (February–March 2011). "The Weighting Game, and Other Puzzles of Indexing" (PDF). Morningstar Advisor. pp. 52–56 [56]. Archived from the original (PDF) on July 29, 2013. Retrieved March 26, 2013.