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High Frequency Trading

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Abby Bormann

on 11 March 2015

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Transcript of High Frequency Trading

Ominous-sounding term for private exchanges or forums for trading securities
Dark pools are not accessible by investing public
Facilitate block trading by institutional investors
Dark Pools
Market Making
Smaller bid-ask spreads
May 6, 2010, 2:45pm
The 2010 Flash Crash
High Frequency Trading
Company of Merchant Adventures to New Lands
First modern joint-stock company
New York Stock Exchange
Wall Street
Most powerful exchange
The ultimate goal of international companies
Algorithmic trading & HFT
More liquidity (efficiency)
Increased usage of dark pools
NASDAQ- 1st electronic exchange
OTC market
Competition for NYSE
Many of the tech giants
Evolution of
The Stock Market

Speed and Efficiency

The Dow Jones Industrial Average lost nearly 1,000 pts in 5 minutes and rebounded 20 minutes later

Types of Dark Pools
Broker- Dealer owned
Pools that are set up by large broker-dealers for their clients and may also include their own proprietary traders.
19 such dark pools
Ex: Goldman Sachs' Sigma X, Morgan Stanley's MS Pool
Agency Broker
Dark pools that act as agents, not as principals. As prices are derived from exchanges. There is no price discovery.
ex: Instinet, Liquidnet, and ITG Posit.
Electronic Market Makers
Pools offered by independent operations like Getco and Knight
They operate as principals for their own accounts
ex: Broker-dealer owned the dark pool, their transaction prices are not calculated from the NBBO
Pros vs Cons
Reduced Market Impact
Market is significantly reduced for large orders.
Exchange prices may not reflect the real market
Pool participants may not get the best price
Vulnerability to predatory trading by HFTs
Small Average trade size reduces need for dark pools
Electronic Trading
45 dark pools consisting of three types: Broker-dealer owned, Agency Broker, and Electronic Market Makers
Future of HFT
The Volcker Rule
Chairman of Federal Reserve: 1979-87

President's Economic Recovery Advisory Board (PERAB): 2009-11
Other Solutions
Consists of....
HFT: International Markets

Europe: FTT

Emerging Markets: Russia, Mexico, Brazil and New Zealand
Lower Transaction cost
Pools don't have pay exchanges fees, so transactions based on the bid-ask mid-point do not incur the full spread.
High Frequency Trading
High Frequency Trading (HFT) is a trading method that uses powerful computers and algorithms to trade a large number of orders at extremely high speeds.
The goal of HFT is simply to take advantage of arbitrage opportunities faster than anyone else.
The Iphone in Louisville sells for $100
The Iphone in Nashville sells for $300
Trading Volume
Tiny price changes occur in the stock when an institutional investor buys or sells a large number of shares.
5 Common HFT Characteristics
The SEC estimates that HFT volume is over 50% of the volume in the overall stock market.
Securities Exchange Act Release No. 34-61358, 75 FR 3594, 3606

*SEC Concept Release
High speed programs used to create, route, and submit orders.
Individual data feeds from exchanges and locations within or nearby the exchanges.
Opening & closing a position in a very short period of time.
Time Frame
Submitting & almost immediately canceling many orders in a short period of time.
Quote Stuffing
Out of most positions by the end of the trading day, not holding overnight.
Arbitrage Opportunity
This creates an opportunity for the HFT firms to buy or short sell the stock.
The profit for each share traded are usually very small amounts, sometimes just fractions of a cent, but when repeated millions of times can result in very large profits.
How HFT Operates
I want to buy 1 million shares of AAPL at a price between $125 to $126 a share.
Will break up the trades into blocks of 100k shares at a time.
The Market
Large Institutional Investor
100,000 shares at $125

Offer Accepted!
First Order
Second Order
100,000 shares at $125
Offer Rejected
It looks like someone is entering batch orders!
Unfair playing field
Exploits supply & demand imbalances
Pros, Cons and Consequences
-Australian Model
-Financial Transaction Tax
Third Order
100,000 shares at $125.10
Offer Accepted
HFT buys
HFT buys
The Market
The Market
HFT sells at
HFT sells at$126.00
September 25th, 1995
Michael Einersen trades 1000 shares of IBM via wireless handheld computers.
January 24th, 2007
Regulation National Market
Order Protection Rule
Access Rule
Sub-Penny Rule
Market Data Rules
Regulation NMS establishes consolidated NBBO
HFT can get views of the market much faster than other firms
What does this mean for individual investors?
HFT uses different strategies for trading
Price < $50
Market Cap > $50 billion
High volume of trading
To avoid competing with HFT,
Buy and hold
Buy equities with lower turnover
Look for strong brands
(C) www.money.cnn.com
High Frequency Trading
Abby Bormann, Jeremy Bozarth, Cole Crider, Alex Gripshover, Shawn Melton, Ashley Weis
Full transcript