high-frequency trading

 

  • “[15] The joint report “portrayed a market so fragmented and fragile that a single large trade could send stocks into a sudden spiral”, that a large mutual fund firm “chose
    to sell a big number of futures contracts using a computer program that essentially ended up wiping out available buyers in the market”, that as a result high-frequency firms “were also aggressively selling the E-mini contracts”, contributing
    to rapid price declines.

  • The study shows that the new market provided ideal conditions for HFT market-making, low fees (i.e., rebates for quotes that led to execution) and a fast system, yet the HFT
    was equally active in the incumbent market to offload nonzero positions.

  • Some high-frequency trading firms use market making as their primary strategy.

  • Using these more detailed time-stamps, regulators would be better able to distinguish the order in which trade requests are received and executed, to identify market abuse
    and prevent potential manipulation of European securities markets by traders using advanced, powerful, fast computers and networks.

  • [80][81] The joint report also found that “high-frequency traders quickly magnified the impact of the mutual fund’s selling.

  • The growing quote traffic compared to trade value could indicate that more firms are trying to profit from cross-market arbitrage techniques that do not add significant value
    through increased liquidity when measured globally.

  • [55] Tracking important order properties may also allow trading strategies to have a more accurate prediction of the future price of a security.

  • The SEC stated that UBS failed to properly disclose to all subscribers of its dark pool “the existence of an order type that it pitched almost exclusively to market makers
    and high-frequency trading firms”.

  • It involves quickly entering and withdrawing a large number of orders in an attempt to flood the market creating confusion in the market and trading opportunities for high-frequency
    traders.

  • Although the role of market maker was traditionally fulfilled by specialist firms, this class of strategy is now implemented by a large range of investors, thanks to wide
    adoption of direct market access.

  • As a result, a large order from an investor may have to be filled by a number of market-makers at potentially different prices.

  • The success of high-frequency trading strategies is largely driven by their ability to simultaneously process large volumes of information, something ordinary human traders
    cannot do.

  • [65] An academic study[35] found that, for large-cap stocks and in quiescent markets during periods of “generally rising stock prices”, high-frequency trading lowers the cost
    of trading and increases the informativeness of quotes;[35]: 31  however, it found “no significant effects for smaller-cap stocks”,[35]: 3  and “it remains an open question whether algorithmic trading and algorithmic liquidity supply are equally
    beneficial in more turbulent or declining markets.

  • The SEC found the exchanges disclosed complete and accurate information about the order types “only to some members, including certain high-frequency trading firms that provided
    input about how the orders would operate”.

  • “[96] The Chicago Federal Reserve letter of October 2012, titled “How to keep markets safe in an era of high-speed trading”, reports on the results of a survey of several
    dozen financial industry professionals including traders, brokers, and exchanges.

  • [1] Various studies reported that certain types of market-making high-frequency trading reduces volatility and does not pose a systemic risk,[10][63][64][78] and lowers transaction
    costs for retail investors,[13][35][63][64] without impacting long term investors.

  • [14] Members of the financial industry generally claim high-frequency trading substantially improves market liquidity,[10] narrows bid–offer spread, lowers volatility and
    makes trading and investing cheaper for other market participants.

  • [108] Order types[edit] On January 12, 2015, the SEC announced a $14 million penalty against a subsidiary of BATS Global Markets, an exchange operator that was founded by
    high-frequency traders.

  • [13] In the years following the flash crash, academic researchers and experts from the CFTC pointed to high-frequency trading as just one component of the complex current
    U.S. market structure that led to the events of May 6, 2010.

  • Filter trading is one of the more primitive high-frequency trading strategies that involves monitoring large amounts of stocks for significant or unusual price changes or
    volume activity.

  • [14] It found that • risk controls were poorer in high-frequency trading, because of competitive time pressure to execute trades without the more extensive safety checks normally
    used in slower trades.

  • HFT firms characterize their business as “Market making” – a set of high-frequency trading strategies that involve placing a limit order to sell (or offer) or a buy limit
    order (or bid) in order to earn the bid-ask spread.

  • By March 2011, the NASDAQ, BATS, and Direct Edge exchanges had all ceased offering its Competition for Price Improvement functionality (widely referred to as “flash technology/trading”).

  • For example, a large order from a pension fund to buy will take place over several hours or even days, and will cause a rise in price due to increased demand.

  • This order type was available to all participants but since HFT’s adapted to the changes in market structure more quickly than others, they were able to use it to “jump the
    queue” and place their orders before other order types were allowed to trade at the given price.

  • [30][88][92] This has led to discussion of whether high-frequency market makers should be subject to various kinds of regulations.

  • [23] As of the first quarter in 2009, total assets under management for hedge funds with high-frequency trading strategies were $141 billion, down about 21% from their peak
    before the worst of the crises,[26] although most of the largest HFTs are actually LLCs owned by a small number of investors.

  • [78] However, after almost five months of investigations, the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) issued a joint
    report identifying the cause that set off the sequence of events leading to the Flash Crash[79] and concluding that the actions of high-frequency trading firms contributed to volatility during the crash.

  • Many high-frequency firms are market makers and provide liquidity to the market which lowers volatility and helps narrow bid–offer spreads, making trading and investing cheaper
    for other market participants.

  • [26] Market share[edit] In the United States in 2009, high-frequency trading firms represented 2% of the approximately 20,000 firms operating today, but accounted for 73%
    of all equity orders volume.

  • “[113][114] Spoofing and layering[edit] Main articles: Spoofing (finance) and Layering (finance) In July 2013, it was reported that Panther Energy Trading LLC was ordered
    to pay $4.5 million to U.S. and U.K. regulators on charges that the firm’s high-frequency trading activities manipulated commodity markets.

  • [33] Market making[edit] Main article: Market maker According to SEC:[34] A “market maker” is a firm that stands ready to buy and sell a particular stock on a regular and
    continuous basis at a publicly quoted price.

  • Flash trading[edit] Exchanges offered a type of order called a “Flash” order (on NASDAQ, it was called “Bolt” on the Bats stock exchange) that allowed an order to lock the
    market (post at the same price as an order on the other side of the order book) for a small amount of time (5 milliseconds).

  • “[58] As computerized high-frequency traders exited the stock market, the resulting lack of liquidity “…caused shares of some prominent companies like Procter & Gamble and
    Accenture to trade down as low as a penny or as high as $100,000”.

  • [77] CME Group, a large futures exchange, stated that, insofar as stock index futures traded on CME Group were concerned, its investigation had found no support for the notion
    that high-frequency trading was related to the crash, and actually stated it had a market stabilizing effect.

  • [47] Tick trading often aims to recognize the beginnings of large orders being placed in the market.

  • [82] Granularity and accuracy In 2015 the Paris-based regulator of the 28-nation European Union, the European Securities and Markets Authority, proposed time standards to
    span the EU, that would more accurately synchronize trading clocks “to within a nanosecond, or one-billionth of a second” to refine regulation of gateway-to-gateway latency time—”the speed at which trading venues acknowledge an order after
    receiving a trade request”.

  • High-frequency trading allows similar arbitrages using models of greater complexity involving many more than four securities.

  • [24][25] Market growth[edit] In the early 2000s, high-frequency trading still accounted for fewer than 10% of equity orders, but this proportion was soon to begin rapid growth.

  • Currently, however, high frequency trading firms are subject to very little in the way of obligations either to protect that stability by promoting reasonable price continuity
    in tough times, or to refrain from exacerbating price volatility.

  • The indictment stated that Coscia devised a high-frequency trading strategy to create a false impression of the available liquidity in the market, “and to fraudulently induce
    other market participants to react to the deceptive market information he created”.

  • [52] Order properties strategies[edit] High-frequency trading strategies may use properties derived from market data feeds to identify orders that are posted at sub-optimal
    prices.

  • [9] High-frequency traders move in and out of short-term positions at high volumes and high speeds aiming to capture sometimes a fraction of a cent in profit on every trade.

  • For example, in 2009 the London Stock Exchange bought a technology firm called MillenniumIT and announced plans to implement its Millennium Exchange platform[70] which they
    claim has an average latency of 126 microseconds.

  • [56] Regulators claim these practices contributed to volatility in the May 6, 2010, Flash Crash[62] and find that risk controls are much less stringent for faster trades.

  • “[93] She proposed regulation that would require high-frequency traders to stay active in volatile markets.

  • [15] The joint report also noted “HFTs began to quickly buy and then resell contracts to each other – generating a ‘hot-potato’ volume effect as the same positions were passed
    rapidly back and forth.

  • [29] The Bank of England estimates similar percentages for the 2010 UK market share, also suggesting that in Europe HFT accounts for about 40% of equity orders volume and
    for Asia about 5–10%, with potential for rapid growth.

  • [91] In their joint report on the 2010 Flash Crash, the SEC and the CFTC stated that “market makers and other liquidity providers widened their quote spreads, others reduced
    offered liquidity, and a significant number withdrew completely from the markets”[79] during the flash crash.

  • The market then became more fractured and granular, as did the regulatory bodies, and since stock exchanges had turned into entities also seeking to maximize profits, the
    one with the most lenient regulators were rewarded, and oversight over traders’ activities was lost.

  • As pointed out by empirical studies,[35] this renewed competition among liquidity providers causes reduced effective market spreads, and therefore reduced indirect costs for
    final investors.”

  • [22] At that time, high-frequency trading was still a little-known topic outside the financial sector, with an article published by the New York Times in July 2009 being one
    of the first to bring the subject to the public’s attention.

  • This strategy has become more difficult since the introduction of dedicated trade execution companies in the 2000s[citation needed] which provide optimal[citation needed]
    trading for pension and other funds, specifically designed to remove[citation needed] the arbitrage opportunity.

  • [98][99] Violations and fines Regulation and enforcement[edit] See also: Regulation of algorithms In March 2012, regulators fined Octeg LLC, the equities market-making unit
    of high-frequency trading firm Getco LLC, for $450,000.

  • [15] The joint report then noted that “Automatic computerized traders on the stock market shut down as they detected the sharp rise in buying and selling.

  • According to a study in 2010 by Aite Group, about a quarter of major global futures volume came from professional high-frequency traders.

  • [109] Reported in January 2015, UBS agreed to pay $14.4 million to settle charges of not disclosing an order type that allowed high-frequency traders to jump ahead of other
    participants.

  • According to the SEC’s order, for at least two years Latour underestimated the amount of risk it was taking on with its trading activities.

  • The order type called PrimaryPegPlus enabled HFT firms “to place sub-penny-priced orders that jumped ahead of other orders submitted at legal, whole-penny prices”.

  • [11] High-frequency traders typically compete against other HFTs, rather than long-term investors.

  • As a result, the NYSE’s quasi monopoly role as a stock rule maker was undermined and turned the stock exchange into one of many globally operating exchanges.

  • Panther’s computer algorithms placed and quickly canceled bids and offers in futures contracts including oil, metals, interest rates and foreign currencies, the U.S. Commodity
    Futures Trading Commission said.

  • A substantial body of research argues that HFT and electronic trading pose new types of challenges to the financial system.

  • [18][19][20] History The rapid-fire computer-based HFT developed gradually since 1983 after NASDAQ introduced a purely electronic form of trading.

  • [1][2][3] While there is no single definition of HFT, among its key attributes are highly sophisticated algorithms, co-location, and very short-term investment horizons in
    trading securities.

  • Academic study of Chi-X’s entry into the European equity market reveals that its launch coincided with a large HFT that made markets using both the incumbent market, NYSE-Euronext,
    and the new market, Chi-X.

  • [23] On September 2, 2013, Italy became the world’s first country to introduce a tax specifically targeted at HFT, charging a levy of 0.02% on equity transactions lasting
    less than 0.5 seconds.

 

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