What is Algorithmic High Frequency Trading, is it unmatchable against the retail trader?
On May 6th, 2010, a single trader in Kansas City was either lazy or careless in executing an enormous trade on the E-Mini futures market twenty minutes later, the broad U.S. securities markets were down nearly a trillion dollars, losing at their lowest point more than nine percent of their value. Certain stocks lost almost all of their value from just minutes before. Confronted with the blistering pace of the decline, many market participants opted to cease trading entirely, including both human traders and High Frequency Trading (HFT) programs. This withdrawal of liquidity accelerated the crash, as fewer buyers were able to absorb the rapid-fire selling pressure of the HFT programs. Within two hours, prices were back near their pre-crash levels. More than five months of research took the SEC to determine what sparked the crash.
High-frequency trading, also known as HFT, is a method of trading that uses robust computer programs to transact a huge number of orders in fractions of a second. It utilizes complex algorithms to analyze multiple markets and execute orders based on market conditions. Usually, the traders with the quickest execution speeds are more profitable than traders with slower execution speeds. In addition to the high speed of orders, HFT is also characterized by high turnover rates and order-to-trade ratios. Some of the most notable HFT firms include Tower Research, Citadel LLC, and Virtu Financial.
Advantages of High Frequency Trading
High-frequency trading, along with trading large volumes of securities, permits traders to profit from even small price fluctuations. It permits institutions to gain substantial returns on bid-ask spreads.
Trading algorithms can scan numerous markets and exchanges. It allows traders to find more trading opportunities, including arbitraging slight price differences for the same asset as traded on different exchanges.
Many proponents of high-frequency trading dispute that it enhances liquidity in the market. HFT increases competition in the market as trades are executed quickly, and the volume of trades significantly increases. The increased liquidity causes bid-ask spreads to fall, making the markets more price-efficient.
A liquid market witnesses less risk associated with it, as there will always be somebody on the other side of a position. Furthermore, as liquidity grows, the price a seller is willing to sell for and a buyer is willing to pay for will move closer together.
The risk can be mitigated with several strategies — one of which is stop-loss order, which will assure that a trader’s position will close at a specific price and prevent further loss.
Dangers of High-Frequency Trading
High-frequency trading remains a controversial activity, and there is small consensus about it among regulators, finance experts, and scholars.
High-frequency traders rarely hold their portfolios overnight, accumulate the tiniest capital, and establish holding for a short time frame before liquidating their position.
As a result, the risk-reward, or Sharpe Ratio, is very high. The ratio is much more significant than the traditional investor who invests with a long-term strategy. A high-frequency trader will occasionally only profit a fraction of a cent, which is all they need to make gains throughout the day.
One major criticism of HFT is that it only creates “ghost liquidity” in the market. HFT opponents point out that the liquidity created is not “real” because the securities are only held for a few seconds. Before a regular investor can purchase the security, it’s already been traded numerous times among high-frequency traders. By the time the typical investor puts an order, the massive liquidity created by HFT has largely ebbed away.
Furthermore, it is supposed that high-frequency traders (large financial institutions) often profit at the expense of smaller players in the market (smaller financial institutions, individual investors).
Finally, HFT has been linked to increased market volatility and even market crashes. Regulators have caught some high-frequency traders engaging in illegal market manipulations such as spoofing and layering.
Some professionals criticize high-frequency trading because it gives large firms an unfair advantage and unbalances the playing field. It can also hurt other investors that hold a long-term strategy and buy or sell in bulk.
- High-frequency trading is an automated trading platform that enormous institutions use to transact many orders at high speeds.
- HFT systems utilize algorithms to analyze markets and spot emerging trends in a fraction of a second.
- Critics see high-frequency trading as an unfair advantage for large firms against smaller investors.
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What is High-Frequency Trading (HFT)? | Talkdelta. https://www.talkdelta.com/post/high-frequency-trading-hft