If you are interested in actively trading securities such as stocks, bonds, and derivatives, you might benefit from knowing about high frequency trading (HFT) and the impact it has on the market.
HFT Basics
HFT involves software programs that make trades in a fraction of a second – which could be a millisecond or a microsecond.
"[O]ne millisecond is made up of 1,000 microseconds. Now take that type of speed, overlay a quantitative investment model most likely using a price reversion strategy, add in millions of orders to buy and sell billions of shares and that, in a nutshell, is HFT," State Street Global Advisers wrote in a document related to the activities of high-frequency traders, according to U.S. News and World Report.
He added that "there are no trade tickets to fill out, there are no phone calls made to brokers, it's all electronic and it's a growing part of the global marketplace."
This practice can help firms generate substantial profits, but who benefits and who bears the cost?
HFT Research
HFT was investigated recently, as U.S. Commodity Futures Trading Commission Chief Economist Andrei Kirilenko worked with researchers from Princeton University and the University of Washington to study trading of the futures contract e-mini S&P 500 between August 2010 and August 2012, according to Bloomberg View.
The economist and the researchers conducting the study were able to cull trading data from individual firms, and also gathered information from futures contracts betting that the S&P 500 Index will either rise or decline in value.
Findings
The research revealed that the firms conducting the largest amount of trading generated the largest profits, which motivates them to trade as much and as often as they can, the news source reports. Also, these market participants profited from the losses of other traders – who traded in smaller volume and reduced frequency.
Kirilenko said in his research that "Whether it is using expedited information to make an investment, reduce risk, or mitigate the costs of adverse selection, those quickest to react to information can best [profit]," according to U.S. News and World Report.
The researcher has studied HFT in the past, investigating the May 2010 "flash crash." He discovered that while this type of trading did not cause the event, it made the situation more severe. He stated that HFT "responses to the unusually large selling pressure on that day exacerbated market volatility," the media outlet reports.
"We believe that technological innovation is essential for market advancement," he wrote at the time. "As markets advance, however, safeguards must be appropriately adjusted to preserve the integrity of financial markets."
Prepare Yourself
Even though this information may seem intimidating, there are many strategies you can utilize in order to cope with the existing situation of the asset market trades being saturated by HFTs.
If you want to learn more techniques to overcome the challenges that HFT poses for individual traders, you can find quality stock trading education available through TradingPub, home to some of the top investors and traders in the industry.
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