According to the Chicago Fed, a handful of high-frequency trading firms were responsible for approximately 70% of all trading volume on U.S. equities markets in 2009. If you think current volumes are low, imagine what it would be without HFT.
- Using these figures, of the 1.2B shares traded daily in new York, over 800M would be by HFTs.
- A single company traded over 2 billion shares in a single day in October 2008, which was over 10% of U.S. equities trading volume for the day.
High-Frequency Trading (HFT)
What is HFT? It is not investing, and it is not something that any investors can do, even day traders.
A small group of trading firms are heavily using in technology to take advantage of high-speed communications, mathematical advances, and high-speed computing - for ultra fast trading. These firms are able to complete trades at lightning speeds, and regular investors do not have a chance to beat them.
"High-frequency algorithmic trading strategies rely on computerized quantitative models that identify which type of financial instruments to buy or sell (e.g., stocks, options, or futures), as well as the quantity, price, timing, and location of the trades. These so-called black boxes are capable of reading market data, transmitting thousands of order messages per second to an exchange, cancelling and replacing orders based on changing market conditions, and capturing price discrepancies with little or no human intervention".
2% of the 20,000 trading firms in the U.S. initiate these transactions. These firms made about $21 billion in profits during 2008. So the chances that these 2% of firms control the market are quite high.
Black boxes going berserk
The paper states that industry experts are concerned over the potential for one or more black boxes going berserk and causing very large losses.
The importance of speed
A main goal of high-frequency trading strategies is to reduce latency, or delays, in placing, filling, and confirming or cancelling orders. This is important because price takers — those whoplace orders to buy or sell — are exposed to market risk prior to receiving confirmation that their orders have been filled. Price makers — those who provide resting bids (buy orders) and offers(sell orders) or respond to buy or sell orders—are exposed to the risk that their prices will remain in the market at a time when the market has moved in the opposite direction of their strategy.
The paper offers some important conclusions.
- The high-frequency trading environment has the potential to generate errors and losses at a speed and magnitude far greater than that in a floor or screen-based trading environment.
- The types of risk-management tools employed by broker–dealers and FCMs, their customers, nonclearing members, exchanges, and clearing houses vary;
- The robustness for withstanding losses from high-frequency algorithmic trading is uncertain.
- These losses have the capability of impacting the financial conditions of the broker–dealers and FCMs and possibly the clearing houses
Therefore, "determining and applying the appropriate balance of financial and operational controls is crucial. Moreover, issues related to risk management of these technology-dependent trading systems are numerous and complex and cannot be addressed in isolation within domestic financial markets. For example, placing limits on high-frequency algorithmic trading or restricting unfiltered sponsored access and co-location within one jurisdiction might only drive trading firms to another jurisdiction where controls are less stringent".