High-frequency trading (HFTs) refers to a trading method that utilizes computer algorithms called “algobots” to make arbitrary profits.
What is high-frequency trading and how does it work?
- High-frequency trading:
- High-frequency trading (HFTs) refers to a trading method that utilizes computer algorithms called “algobots” to make arbitrary profits through price changes in very small amounts at almost instantaneous time intervals.
- Advantages of ultra-high frequency trading:
- Amazing speed, high turnover, order-trading rate.
- Is Ultra-Frequency Trading Ethical:
- HFTs are usually used to improve liquidity, but when you look at their transaction speed, the liquidity provided by HFTs often disappears as quickly as that. This “ghost liquidity” prevents traders from placing orders, eventually pushing small investors out of the market.
The stock market doesn’t fluctuate. It requires the ability to focus attention and calmly deal with any situation. With trillions of dollars of trading volume coming and going around the world every day, a single error is unacceptable.
An inherent characteristic of healthy financial markets is liquidity. If no one is willing to buy, the value of the asset is lost. Brokers, called “market makers,” provide this liquidity to make a profit and offer trades at any price level in exchange for a fee. Percentage cuts are getting smaller as the market grows and becomes more mechanically proficient, but brokers are also constantly evolving.
What is ultra-high frequency trading?
Computers are a long way from being intelligent enough to replace all humans, but their ability to do multiple tasks at the same time is still better than humans. High-frequency trading (HFTs) is a trading method that utilizes computer algorithms called “algobots” to make profits by changing prices in near-instantaneous time intervals.
How does HFT work?
In the blink of an eye, HFTs can place orders and make money, reducing the efficiency of passive market makers. Although HFTs are commonly used by hedge funds and other institutional investment firms, the use of bots in trading can also be a huge help to small investors.
Bid -ask spreads are very low compared to 20 years ago. This is partly because of the change in 2001 to allow trading in decimal rather than hexadecimal fractions. However, e-trading has improved market liquidity. The study found that since the Canadian government introduced fees limiting HFTs in 2012, the difference between buying and selling prices has risen to 9%.
However, not all HFTs are positive and profitable. The long-term impact of large-scale algorithmic trading on both the market and small investors remains ambiguous. As the difference between bids and bids decreases, the return on liquidity may be low enough to exceed a certain threshold.
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Advantages of ultra-short trading
HFT’s fast execution speed
HFT is a method that utilizes a computer program to pour out large volumes of transactions in less than a second. Utilizing complex programs, HFT analyzes multiple markets at once and executes orders when triggers set for specific market conditions are triggered. In most cases, the faster the transaction execution speed, the higher the profit.
Incredible speed, high turnover, order-to-trade rate
In addition to its incredible speed, high spin lines and order-to-trade rates are also hallmarks of HFT. This form of trading became popular as exchanges began to incentivize companies to generate liquidity after the collapse of Lehman Brothers in 2008.
History of HFT
The New York Stock Exchange (NYSE) leveraged Supplemental Liquidity Providers (SLPs) to add competition to the liquidity quotes of existing exchanges. The average SLP rebate is far less than a cent, but it’s still incredibly profitable when you factor in millions of trades per day.
In 1998, the Securities and Exchange Commission approved automatic trading, and HFT trading began about a year later. At that time, transactions still took seconds to execute, and it was not until 2010 that they reached milliseconds. With today’s ever-increasing computational power and increasingly faster automated transactions, HFTs make decisions in less than a hundredth of a microsecond.
HFT’s huge overseas growth potential
HFT has tremendous overseas growth potential. Because stock exchanges around the world are more open and even supportive of this concept. However, lawsuits ensued as exchanges provided HFT with unjustified time benefits, and opposition is slowly growing.
In 2012, France first announced that it would impose an individual tax on HFTs, followed quickly by Italy. A 2014 study evaluating the impact of HFTs on volatility in financial markets came to the ambiguous conclusion that no single cause for these fluctuations could be identified. The study did not rule out the idea that HFT could pose risks to future financial markets, but it did not draw conclusions about the extent of its capabilities or the process.
High dominance
Over the past decade, algorithms and HFTs have largely dominated the trading world. More than 60% of US trades in 2009 and 2010 were HFTs. Of course, this share has declined since then. HFT is a type of algorithmic trading that divides large orders by order time period and manages them even after placing the order.
What is the principle of the algorithm used in HFT?
Large orders placed by annuity or insurance companies have a significant impact on stock prices, and algorithmic trading seeks to reduce the impact by dividing these orders into multiple trades. Because HFT is based on a large number of orders, it helps in both price discovery and price formation.
In addition, the algorithms used in these systems properly control order dispatch schedules, read real-time data feeds, log trade signals, and spot arbitrage opportunities. In fact, these Algobots even trade based on current trend forecasts and market news.
The HFT algorithm benefits from the difference in bid price through double-sided orders. It also tracks small orders and analyzes patterns and trading times to predict the likelihood of large orders. In these cases, the HFT algorithm capitalizes on high-volume waiting orders and adjusts prices to fill orders.
HFTs are usually considered the property of professional companies, and traders or small investors are not particularly relevant. Not only do HFTs require the fastest computers, they also require regular and expensive hardware upgrades. In addition, these devices must be installed in expensive facilities located as close to the exchange servers as possible.
Being able to access the data feed in real time avoids even the slightest delay and avoids computer algorithms that do efficiency warfare with other HFTs.
Is ultra-high frequency trading ethical?
Ideally, HFTs require minimal latency and maximum automation. In other words, HFT companies are more likely to trade in the market with a high degree of automation. According to a 2011 Deutsche Bank report, HFT participants basically consist of an asset trading company and an associated trading desk, with hedge funds also participating to a small extent.
Disadvantages of short-term trading
High liquidity and low bid gaps are good for markets, but HFTs incur costs and these costs are not always obvious to investors. When exchanges utilize HFT companies to market, they provide access to new orders. This will allow you to see the size of your trades before they affect the market.
If a large number of purchases come in through one exchange, HFT accumulates shares in other exchanges and sells them at a higher price. Some argue that it’s like paying for a trading advantage and doesn’t seem to do much to improve liquidity in the real stock market. Professor Barnard Professor Rajiv Sethi called it “unnecessary financial intervention” by intervening between buyers and sellers rather than making markets more efficient.
HFTs often make other market participants uneasy. Because no one wants to compete with robots that trade faster than they say “money”.
Economists call this “adverse selection,” which affects other HFTs as much as it affects small investors. Competition with HFT leads to fake quotes or “spoofing”. By creating a transaction, we get other algobots out.
Some critics believe that HFTs don’t create as much market as betting directly on stocks, resulting in low liquidity and high daily volatility. Others point out that although HFTs are profitable, they do not add value to financial markets and have high competitive costs. In 2012, Knight Capital suffered a loss by buying and selling nearly $7 billion of stock. The accident was caused by an upgrade of a recently installed software.
The error cost $440 million, and Getco eventually acquired the company to establish KCG Holdings, but it’s still struggling. The biggest bottlenecks for HFT growth are declining revenue potential, high operating costs, regulatory issues and potential for error.
Spread Network is famous for spending $300 million to install fiber optic cables from Chicago to New York to improve transaction speed. There are no silver medals in HFT Wars. Not only the primary investor, but also whether or not they are faster than other Algobots determine the success or failure of a competitive strategy. This means that as soon as one HFT improves, the other HFT does not catch up with its investments, which means it will fall behind its competitors and lose money.
HFT doesn’t just rely on fast data transfer rates, it’s also about the speed at which algorithms process information and decide what action to take. A more efficient algorithm can help improve time slightly, but this complex task requires the smartest people in the world, and it doesn’t seem like the best way to utilize human resources. Experts also point out that although HFT reduced the chance of random decisions from 97 million seconds to 7 million seconds, profitability did not change significantly.
The technological innovation ratio seems to open up endless possibilities for trading, but the regulatory system is just too hard to keep up with. When these systems first emerged, only a handful of companies were able to take advantage of these great advantages, as algorithms and HFTs are a matter of how quickly they place orders. HFT can be a daunting factor for traders in well-established markets, but emerging markets can still benefit from large staked HFT ventures.
What is the future of HFT?
HFT is a controversial topic and has been the subject of considerable criticism over the years. HFT, replacing broker dealers with algorithms, can make decisions in a million seconds and have a broader impact on the market.
In 2010, the Dow Jones Industrial Average suffered its biggest one-day drop of 1,000 points and fell more than 10% in 20 minutes before picking up again. A government investigation into the incident led to the conclusion that HFT’s high volume orders caused a massive sell-off and led to its collapse.
HFT is usually used to improve liquidity, but looking at its transaction speed, the liquidity provided by HFT often disappears as quickly as that. This “ghost liquidity” prevents traders from placing orders, eventually pushing small investors out of the market. For example, an exchange may delay the rate at which information is sent to the HFT or use periodic batch auctions rather than placing orders in a row.
This gives you more control over your trading opportunities, rather than asking prices to fill in milliseconds. The actual effect of HFT on financial markets is difficult to quantify. Creating a better market structure in a situation where its impact is unavoidable will make HFT less relevant and trading as a whole will improve.
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Comment by Hans
April 24, 2024
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