What is It and What Is Being Said About It?
High Frequency trading is a trading strategy that has become common in changes across the world. If you have read 'The Dark Side of Trading' then you do not need an introduction with the term, but we are expecting novices to come and read about this recent market evil which has forced several Wall Street firms in America issue statements against the use of this method.
What is HFT (High Frequency Trading)?
The use of supercomputers in executing trades at a very high speed is called high frequency trading. In the past, traders used to trade hundreds and sometimes thousands of trades every second. With the recent development of computing powers, traders use highly powerful computers dedicated towards this to make millions or more trades every single second!
What is more worrying is that these highly powerful machines may overload exchange servers, causing them to crash. They also have the power to predict the flow of trade and position their strategy to manipulate the market to aggregate small benefits over prolonged periods of time.
By many estimates, HFT forms more than 70% of the transactions carried out at major firms across the world, including those in Australia. This figure speaks volumes about the acceptance of the superiority of bots over ethical trading strategies.
Why Traders Use High Frequency Trading
The motivation behind using these highly powerful computers to place bids is simple. Computers can overtake humans when it comes to placing bets at a very high speed. Suppose, a stock is offered simultaneously at two markets with a slight difference in the prices. With HFT, the trader can buy the cheap and sell the cost market accumulating some profit along the way on every trade. This method has very little to do with the Fundamental or Technical Analysis taught at trade training institutions in Australia or abroad.
The largest gripe with High Frequency Trading is its potential to cause significant distortions in the financial markets in matter of moments. We know quite well that a lot of instability in local markets can be detrimental to the international financial scenario too, which makes high frequency trading the tool for gradual destruction. Let's look at an example.
How High Frequency Trading Screws Traders!
On Aug 3, 2012 there was a significant incident that rocked Knight Capitals. The firm would have become bankrupt but for Jeffries Group Inc. who came to rescue. What flipped the kill switch at Knight Capital? Well, it was an algorithm that was supposed to make fast trades and make a lot of money for Knight Capital, instead it issued buying offers that cost them their shirts — and everything happened in less than 30 minutes!
Algorithmic trading practices are not in the best interest of the long term market and can cause serious damage to the economy of a country not to mention, bankrupt traders in bare seconds.
The reason this happened is because software developers test their applications against old historical data but there is no way to pitch it against unforeseen turns and twists.
What is the Latest Take on High Frequency Trading?
As already mentioned, HFT is responsible for a huge section of the trades being transported out in the USA and UK. Thus, post the Knight incident, electronic trading centers and firms all over the globe breathed down the neck of techies and ensured that their algos were working fine.
There is no sign of this slowing down because of the huge benefits provided by it. In some cases, HFT is the only way out because of the highly fragmented nature of the market, for instance the cash equities market. Others, who have tasted blood with this method, are ready to go to war rather than stop using HFT.
ASIC (The Australian Securities and Investments Commission) recently reiterated the fear expressed everywhere over the proliferation of machines and algorithms in the market. Not only is this unfair, it robs the orderliness of the market, it also denies the average trader a fair chance to make money.
High Frequency Trading is not the best thing, but the greed in traders will keep it alive and improve it in the near future. Critiques notwithstanding, technical gurus are at work; trying to sort out glitches and installing kill switches to allow intervention if something goes wrong. What remains to be seen is the final standoff between men and machines on the trading floor!