HIGH FREQUENCY TRADING
So far, the above seems to be the
most comprehensive attempt to define such a trading practice. One needs to note here that HFT has brought about a revolution in the institutional processes in which trading has been traditionally perceived.
Evolution of HFT Apart from bringing about
important transformations in the context of price dissemination and risk management practices, an important microstructure revolution occurred in the markets in the form of the movements from open
HFT, Just Imagine …
“As of today, the lower limit for trade execution appears to be around 10 micro-seconds. This means it would in principle be possible to execute around 40,000 back-to-back trades in the blink of an eye. If supermarkets ran HFT programmes, the average household could complete its shopping for a lifetime in under a second.”
Speech by Mr. Andrew G Haldane, Executive Director,
Financial Stability, Bank of England, at the International Economic Association World Congress, July 2011.
outcry (or pit trading) systems to online trading systems. This development ensured a broader level of participation of heterogeneous groups, by transcending geographical boundaries. Electronification of trading practices has enabled trading with a computer algorithm (program) deciding on certain aspects of the order (such as timing, price, quantity, venue) without human intervention. The development of information
and communication technologies has opened up vast opportunities for innovation in trading markets, including the rise of HFT. Ever since computerized trading of stocks became a significant part of Wall Street in the 1980s, the applications of computing technology in markets has mushroomed. Further, improvements in network architecture and low cost computing have encouraged trading houses to opt for faster means of trading to out-run competitors. In this context, to reduce the latency in trade execution, exchanges started
76 March 2012
allowing clients of the brokers to directly access the exchanges’ trading engines – direct market access. To further reduce the time between order initiation and execution, exchanges also allowed brokers to host their servers in close proximity to the exchanges’ servers – co-location. Eventually, the algorithms that guide the trading process also got more sophisticated, inadvertently leading to the rise of trade execution at high speed. This marked the evolution of HFT. One of the critical drivers of these developments emerged from
the regulatory dimension across different markets in different regions that helped evolve the rules of trading. The National Market System (NMS) in US led to decimalization of stock prices and hence prompted more use of technology in trading. In Europe, the Market in Financial Instruments Directive (MiFID) enforced the abandonment of the concentration rule on equities trading, thus giving birth to Alternative Trading Platforms, Dark Pools, Electronic Communication Networks and the like. With securities traded at multiple venues, in order to capture
the arbitrage opportunity faster than competitors proprietary traders began to deploy super-fast computers. This tremendous advancement in technology also ensured a substantial reduction in the execution time of HFT trades from over a few seconds at the beginning of the new millennium, to a few microseconds by 2010. Today, The timing of trading can be as low as 500 microseconds i.e. 1/400th
time taken for a blink of an eye. Notably, while HFT techniques are currently used by renowned
and well-established banks and hedge funds, it is new independent firms that account for majority of HFT trading.
HFT in Different Contexts Some regulators have sought to identify types of trading
strategies or behaviours that are often used in HFT. The US Securities and Exchange Commission (SEC) in its 2010 Concept Release on Equity Market Structure, identified four types of trading strategies as illustrative of HFT: passive market making, arbitrage, low latency trading, and directional strategies.3 Passive Market Making: The majority of US Equity HFT is employed in the strategy of liquidity provisioning, also known as electronic market making. Historically, such a service was provided by NYSE specialists and NASDAQ market makers but, with the advent of decimalization, human specialists and market makers were no longer able to keep up with the liquidity demands of investors and automated technology became necessary for this function. Arbitrage: New regulations – such as Regulation Alternative Trading Systems (ATS), decimalization requirements and Regulation National Market System (NMS) in US and Financial Instruments Directive (Mifid) in Europe – spurred competition among exchanges and other platforms, fragmenting trading and creating arbitrage opportunities for HFTs. With advancements in ICT, easy access to different trading platform and comprehensive computer linkages among trading venues provided HFT users with further opportunities for arbitrage. Low Latency Trading:Direct market access has enabled executing trading flow on a selected venue by bypassing the brokers’ discretionary methods. In these strategies, computer scientists rely on speed to gain time advantages in arbitraging price
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