HIGH FREQUENCY

TRADINGWhen speed and brain matter!!!!!!!!!

A journey in a world of algohoritms

THE MAIN POINTS (1) Make some pennies on extremely small differences in

price

Algorithm based strategies = go to the beach and let the PC work

How it works? Steal information from informed investors

Effects on market liquidity. Do small investors like HF traders?

Where is the leverage? High Sharpe Ratio

A bet on informed investors

Focus is on predicting order flow – what trades will be executed in the next few seconds – rather than information about the underlying stocks.

Devote tons of effort to predicting which order flow is informed, and moving the price accordingly• Generally move prices in the direction of future information

flows (Good for moving prices efficiently)

• Bad for informed traders, who make less money although they have the right information

HIGH SHARPE RATIOS

return premium per unit of risk

No leverage=low standard deviation

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THE MAIN POINTS (2)

No leverage because they should wait for informed investors! What if they borrow money and no one take huge positions?

Do we need market inefficiency?

In April 2012, Canadian Regulators increased fees for HFT, what happened?

Economics theory and HFT, is it good?

A History of High Frequency Trading

In the Beginnning

Has taken place at least since 1999, after the U.S. SEC authorized electronic exchanges in 1998.

In early 2000s HFT accounted for less than 10% of U.S. equities orders. But from 2005-2009 HFT orders grew over 164%. From 2008-2011 67% of equity trades were executed by HFT firms. Was a little-known topic outside the financial sector until recent

By 2010, HFT accounted for more than 60 percent of all U.S. equity volume and seemed positioned to swallow the rest. 

The Flash Crash Instigated by a single sale of $4.1 billion in hedging futures contracts Waddell & Reed Financial.

High-frequency traders quickly magnified the impact of the mutual fund's selling by front-running orders.

Essentially ended up wiping out available buyers in the market. HFTs began to quickly buy and then resell high volume contracts to each other.

The liquidity in the market evaporated because the automated systems used by most firms to keep pace with the market stopped or paused.

The resulting lack of liquidity caused shares of some prominent companies like Procter & Gamble and Accenture to trade down as low as a $.01 or as high as $100,000.

Today

For the first time since its inception, high-frequency trading is in retreat.

According to estimates from Rosenblatt Securities, as much as two-thirds of all stock trades in the U.S. from 2008 to 2011 were executed by high-frequency firms; today it’s less than half. 

By 2009, high-frequency traders moved about 3.25 billion shares a day. In 2012, it was 1.6 billion a day.

Also, average profits have fallen from about 1/10th of $.01 per share to a 1/20th.

“The margins on trades have gotten to the point where it’s not even paying the bills for a lot of

firms,” -- Raj Fernando, CEO of Chopper Trading

High Frequency Traders under investigation

by the FBI, SEC and CFTC

Insider Trading

• Front Running: HFTs spot bids before anyone else on one exchange, and then move to another exchange to buy it in time to unload it on the original bidder at a higher price.

• Illegal Tips: HFTs place orders using complicated algorithms to conceal that their transactions are based on illegal tips

Market Manipulation

• Wash Trading: High frequency firms distort futures markets as by acting as buyers and sellers in the same transaction.

• HFTs place a group of trades and then cancel them to create false appearance of market activity.

Other Investigations

• SEC and CFTC investigating if some major exchanges give preferential treatment to HFT.

• HFTs are accused of trading on information about client orders before executing them.

• FBI officials are also looking into whether brokers use information on after-hours trading to beat the market next morning