The Wonderland of HFT: Myths & Realities
With high frequency trading (HFT) techniques becoming more popular in different asset classes (including commodities) they are also being increasingly scrutinized by regulators.
By Dr. Nilanjan Ghosh, Niteen Jain, & Nazir Ahmed Moulvi
DESPITE HFT BEING highly debated, even as research studies in this field are still preliminary, regulators in the United States and elsewhere are already looking to crackdown on computerized high-speed trading, largely on the apprehension that it distorts markets and exacerbates market swings. In fact, the European Union is considering listing “specific examples of strategies using algorithmic trading and high-frequency trading” that should be banned and punished by regulators as market manipulation. However, it is imperative that before any restrictive decision is taken on HFT regulation, intense research is necessary to study its impact on trading markets. The unprecedented rise in HFT in recent times can
be discerned from the fact that volumes accounted for less than a fifth of US equity market turnover in 2005. Today, HFT accounts for anything between two-thirds and three-quarters of trading volumes.1 More importantly, HFT has extended its reach both geographically and into other asset classes. Besides engaging in proprietary trading, many
high frequency trading firms also act as market makers to provide liquidity, thereby narrowing bid-ask spreads. HFT, therefore, is a special class of algorithmic trading, in which supercomputers make very quick and elaborate decisions to initiate orders based on information that is received electronically, before human traders are capable of processing the information they observe. This has resulted in a dramatic change in some critical market microstructure issues, particularly in the way liquidity is provided.2
.. a precise definition for HFT
may not even be practicable for regulatory purposes
In November 2011 the Commodity Futures
Trading Commission (CFTC), with its technology advisory group, proposed to kick-start a discussion on defining HFT and noting following seven-points.
• The use of extraordinarily high-speed order submission/cancellation/modification systems
with speeds in excess of five milliseconds or generally very close to minimal latency of a trade;
• The use of computer programmes or algorithms for automated decision-making
where order initiation, generating, routing, and execution are determined by the system without human direction for each individual trade or order;
HFT is often used interchangeably to refer to several
related but distinct computer-based trading concepts. These include computer-based trading characterized by high portfolio turnover and high order-to-trade ratios, algorithmic trading, market making, and other forms of computer-based trading that employ sophisticated technological tools. Notably, European financial regulators, in proposed revisions to MiFID, have defined algorithmic trading as “a computer algorithm [which] automatically determines individual parameters of orders ... with limited or no human intervention”. When it comes to defining HFT, securities regulators have recognized that setting a precise definition for HFT “may not even be practicable for regulatory purposes”. Hence, despite the high and growing popularity of HFT, there does not appear to be an agreed definition of HFT among regulators, academics, and the media.
Source: IOSCO, SIFMA and
consilium.europa.eu
• The use of co-location services, direct market access, or individual data feeds offered by
exchanges and others to minimise network and other types of latencies;
• Very short time-frames for establishing and liquidating positions;
• High daily portfolio turnover and/or a high order-to-trade ratio intraday;
• The submission of numerous orders that are cancelled immediately or within milliseconds
after submission;
• Ending the trading day in as close to a flat position as possible (not carrying significant,
un-hedged positions overnight). March 2012 75
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