High Frequency Trading

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High-frequency trading, or HFT, is a system that involves market data, algorithms, software and high-end powerful computers to make multiple trades per second. Traditionally, traders sit on trading floors and utilize hand signals to buy and sell stocks. However, with HFT on the rise, traders now rely on technology to analyze multiple markets and execute multiple trades simultaneously at very high frequencies. These platforms have increased transactions speeds relative to traditional trading. Furthermore, some traders have benefited from HFT as traders with faster execution speeds profit more than those who are slower. As HFT begins to take a larger share of the equity market, it is beginning to raise ethical concerns.

History

• • In 1602 The world's first stock exchange - Amsterdam Stock Exchange begins trading securities.
• •In 1983 Bloomberg terminal comes out and it is the first computing system that provides real-time market information, which supports trading.
• •In 1998 SEC authorizes high-frequency trading.
• •In 2010 HFT accounts for 50% of the equity market.
• • In 2012 the share of HFT increase to 70% of US equity trading.
• • In 2014 HFT starts supporting bitcoin.

Features

High-frequency trading firms are market makers and provide liquidity to the market. They narrow bid-ask spreads which lead to lower trading costs.

Liquidity

Liquidity is the ability of an asset to be sold on the market, the easier to sell, the higher the liquidity it has. When making an investment, investors take the liquidity of assets into consideration. In most cases, investors prefer high liquidity assets. The amount and volume of the trades using the HFT platform ensure a liquid market. Thus HFT improves market liquidity and eases the effects of market fragmentation. As HFT trades can make up as much as 70% of the trading volume on a given day, investors have a greater ability to be matched up with a counterparty.

Market-making

Market making means placing an order to sell (ask) above the current market price or a buy limit order (bid) below the current price to capture the bid-ask spread (the difference between the selling price and purchase price) and make a profit. This strategy provides market liquidity and makes sure traders can always move funds.

Bid-ask Spread

The bid price is the highest price a buyer will pay for a security, and the ask price is the lowest price a seller willing to sell the security. Investors face a bid-ask spread which is the difference between the selling price and purchase price. HFT narrows the spread due to the ability to create liquidity. The small spread means an investor can purchase equity with a price that only a little bit higher than the selling price. Hence, HFT provides low trading costs.

Latency Arbitrage

Arbitrage is an opportunity that gets profit without any risks. It is an act that takes advantage of a price difference to trade across multiple markets since assets might have different prices on different exchanges. A trader can make profits buy identifying arbitrage opportunities and make executions. Latency arbitrage means getting this advantage by being faster. HFT can take this advantage due to the speed of trading. There are a number of theoretical models use HFTs to motivate their informational structure. The result shows that HFT receiving information slightly ahead of the rest of the market. HFT can predict price changes over horizons of less than 3 to 4 seconds.

High Frequency Trading Firms

Citadel Securities

Founded in 2020, Citadel Securities is a leading global market maker across a broad array of fixed income and equity products. Its platform can help to meet the liquidity needs of asset managers, banks, broker-dealers, hedge funds, government agencies, and public pension programs. Citadel Securities accounts for over 10% of U.S. equity trading volume.

Two Sigma Securities

Founded in 2009, Two Sigma Securities is a broker-dealer registered with the SEC, and a registered market maker in over 8,000 U.S. exchange-listed equities. It has $50B asset under management and its platform can trade more than 300 million shares per day.

Virtu Financial

Virtu Financial was founded in 2008 by Vincent Viola and Doug Cifu. It is one of the largest high-frequency market makers which provide deep liquidity and competitive bids and offers in over 25,000 securities.

Ethical Concerns

Bias

Algorithms were written by humans so it cannot avoid bias. It may generate bias-driven orders it unsophisticated trader written the algorithms. John and Andrei Nikiforov wrote a paper about human bias in algorithmic trading and they found out that most trades were completed within just 30 seconds after the end of a “round” time interval such as 9:45 AM or 10:00 AM. Buy-side institutional traders who need to have execution throughout the trading day, tend to pick round numbers and intervals to execute the trade. Even though traders utilize algorithm that breaks down a large order into smaller pieces, the default settings for the execution timing are under the “round –number-preference” bias.

Market Manipulation

HFT can give traders an unfair advantage if they engage in market manipulation. A trader would be driving interest in a lightly-traded stock from which he or she would profit through market manipulation. On Oct. 16, 2014, The Securities Exchange Commission charged a New York-based trading firm of manipulating the closing price of thousands of Nasdaq-listed stocks from June to December 2009. By using an algorithm, Athena Capital Research made its trading at the end of the trading day in order to impact the stock prices. “The massive volumes of Athena’s last-second trades allowed Athena to overwhelm the market’s available liquidity and artificially push the market price—and therefore the closing price—in Athena’s favor. Athena was acutely aware of the price impact of its algorithmic trading, calling it ‘owning the game’ in internal e-mails,” the SEC wrote in a release. If huge trading firms perform like this, they can control the stock price as what they desire and individual investors or small firms have to follow the price.

Unfair to Small Investors

Hedge Fund companies take advantage of the fast computing system, but individual investors, brokerage firms, or small institutions without access to the expensive computing facilities become harder and harder to gain from the market. According to estimates, the trading volume on U.S exchanges executed by high-frequency computers range from 50 percent to 73 percent. Market research firm, IBIS World, estimated that the high-frequency trading industry is a $29 billion enterprise. As HFT keeps developing, individual investors will have limited access to the market.