High Frequency Trading

this is what the stock market was once like a large room with monitors on the wall showing continually changing columns of numbers on the floor a hectic crowd of traders and a babble of voices from which one repeatedly heard the shouts buy and sell but this picture has changed the room is still there along with the monitors but the crowd has become much smaller quietly humming computers have taken their place the traders who monitor and control the computers are either sitting at home or in the office these computers work much faster never go on holiday and rarely require a person to run them these computers are equipped with trading programs based on mathematical formulas known as algorithms instead of the traders it is these programs that evaluate stock market rates and are able to buy and sell stocks either fully or semi automatically some of these trading programs only perform simple commands for example when the price of grain falls below a certain value then by X number of grain stocks other programs can follow several commands at once and are relatively complicated but they are nothing compared to custom-built high-frequency trading computers the trading programs installed on these computers can independently pursue complex strategies with incredible speed these programs compete with and battle one another to ensure they don't run the risk of losing they always have to be faster more flexible and more independent what was previously traded within days hours and minutes is now bought and sold within seconds milliseconds and microseconds high-frequency traders only account for a small part of all traders yet are responsible for about two-thirds of all stock market transactions the high-frequency traders basic strategy is very simple trade as much and as quickly as possible the profit margin on each transaction is frequently quite small but these small amounts add up to billions due to mass and velocity to make this work the high-frequency trading programs must always be a split second faster than the others and that's only possible when they are close to the stock market the shorter the cable the faster the information can be transmitted it's all about milliseconds for example the buying price of a certain commodity Rises minimally since the high-frequency trading programs can process this information before other trading programs they have the opportunity to be the first to respond to the price trend before the trend ends the commodity stocks are sold again at a minimum profit per share high frequency trading may have advantages and disadvantages for the markets many market researchers believe that high frequency trading increases so called liquidity a market has a high level of liquidity when a trading partner can be found for every offer however high-frequency traders work especially well in markets that are already highly liquid what's more they are not obliged to always act as trading partners in a crisis situation when they are most required high-frequency traders pull back from the market and this benefit is lost some also think that high frequency trading facilitates pricing while reducing price volatility however these assertions are highly controversial as some high frequency trading mechanisms have the opposite effect disadvantages include the fact that normal traders cannot match the speed of the high-frequency traders because firstly not everyone can afford to rent space close to the market and secondly they cannot always pay for the specially programmed high-frequency trading algorithms due to more direct proximity to the stock market the high-frequency traders have a clear information edge this means that all classic dealers lose out to high-frequency trading effectively every classic trader not only pays the explicit exchange fees but also an implicit fee for high-frequency trading because this type of trading is interposed between most stock market transactions another drawback is that the novel high speed and the lack of regulation are often exploited by high-frequency traders to manipulate the markets and deceive other market participants one example here it is difficult and costly to continually stay one step ahead instead it is easier to slow down all other market participants this happens through so-called quote stuffing in this scenario a trading program makes thousands of small unimportant offers thereby producing a flood of information and filtering out the unimportant information other programs lose valuable milliseconds and respond too late to the interesting offers another manipulation technique is called spoofing for example a trading program will generate a number of overpriced purchase offers thanks to the extreme speed these overpriced offers can be cancelled immediately before anyone purchases them but as these phantom offers are nevertheless seen this creates the illusion that a number of dealers are interested in buying the offers and that prices for these goods will soon rise significantly other traders react to this illusion insuring that the price actually does rise the spoofer can now use previously acquired options bought at an unmanipulated price to make significant profits controlled high-speed trading also comes with technical risks trading algorithm programmers say that due to the extreme complexity of the trading environment and the algorithms themselves they are no longer able to track everything the program's do and of course these programs are never completely error-free this leads to problems in the interaction of various trading programs as with human dealers unpredictable situations can arise for example when two or more programs repeatedly react to one another and subsequently get trapped in a loop the problem here is the speed with which this happens only special programs would be able to react quickly enough as humans are much too slow to become aware of the threat assess it and intervene these risks and manipulations are detrimental to the vast majority of market participants and cannot be compensated for by the benefits in addition to the already unfair advantages for high-frequency traders all these problems can have fatal consequences on the real economy they played a large role in stock market crashes such as the first flash crash of 2010 when the US stock market collapsed within a few minutes in a way never seen before since then mini flash crashes have repeatedly been observed in every Stock Exchange despite claims of immunity to such a problem the German stock market experienced its first real flash crash in early 2014 unfortunately technical product with computerized trading has led to a wide range of risks and possibilities of manipulation which are predominantly exploited by high-frequency traders in order to counter these the following reforms of European stock exchange acts were adopted in the spring of 2014 the introduction of automated trading stops if flash crashes occur trading will be interrupted briefly flash crashes cannot be prevented like this but the damages can at least be limited the increase of the so-called tick size this is the minimum amount by which a market price can change this represents an indirect regulation of high-frequency trading as price changes would occur less frequently the following regulations were unfortunately left open by the stock markets and are not sufficiently anchored in law the stock exchanges thus find themselves in a conflict of interest as they are mainly benefiting from high-frequency trading to begin with the stock markets are being directed to make privileged electronic connections to stock exchange computers fair and transparent for all market participants however as long as slower and faster connections exist this will lead to structural inequality on the markets penalizing those traders who only have access to a slower connection quote stuffing and spoofing will still remain possible privileged connections to exchange computers so-called collocations should be eliminated in order to restore equal opportunities for all market participants likewise Stock Exchange operators have unfortunately only been asked but are not obliged to prevent the massacre insane tum' offers there are two options for dealing with us either by introducing limits on offer cancellations or introducing a minimum holding period for offers the European Parliament has proposed 500 milliseconds as the minimum retention period but unfortunately was unsuccessful in this initiative embedding one of these options in law would be especially advantageous as it would stringently prevent quote stuffing and in particular spoofing while also promoting equal opportunities for all market participants facilitating pricing and preventing flash crashes lastly there are two further ways to regulate high-frequency trading the enforcement of a minimum holding period for securities would mean that it would not be possible to immediately resell shares that have just been acquired this would prevent high-frequency traders from interposing themselves on every transaction conducted ultimately the introduction of the much-vaunted financial transaction tax would make high frequency trading less lucrative and in all likelihood offset the social losses on the financial markets through tax revenues advantages of high-frequency trading are largely overestimated while the disadvantages are systematically swept under the carpet it's not about preventing computer-assisted trading but rather preventing extreme forms of trading that are harmful to society to ensure that innovations and technical developments on the financial markets are not abused we should ensure that they are accompanied by the appropriate legislative reforms you

Channel: WEED e.V.

Views: 464,145

Keywords: High-frequency Trading, Politics (TV Genre), flash crash, financial markets, financial reform, financial market reform, trading, high speed trading, flash trade, flash trading, spoofing, quote stuffing, noise trading, market making

Id: z4nCTdQlH8w

Length: 11min 2sec (662 seconds)

Published: Mon Sep 01 2014

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