Exploding The Myths Of High Frequency Trading
In the last couple of years, there has been a significant growth of high frequency trading (HFT) in the US equities markets. With that growth has come a good deal of controversy. Many people talk about high frequency trading, but not so many actually understand it, a situation which has led to a number of myths and misconceptions doing the rounds. In this article, I will try to address some of the more common myths.
First of all, a quick explanation. High frequency trading is where traders send multiple orders into the market electronically, to capitalise on opportunities arising from small differences in prices. Positions are generally only held for a few minutes at most, and high frequency traders always end the day flat.
So far, so good, but why is this so controversial? There are a number of reasons. First, there is the fact that proprietary high frequency trading firms tend to be profitable and because people generally don't know how HFT works, they think that those profits must come at the expense of retail or institutional investors. Second, the media like to portray high frequency traders as the "bogeymen" of the market, using their computer systems to fleece the investing public. Third, events like the "flash crash" of May 6th whip up commentators to blame such market instability and volatility on high frequency traders.
There are many misconceptions about high frequency trading. One of the most common of these is that high frequency trading is the cause of market volatility. Think about this logically for a second. High frequency trading strategies can only operate under conditions of volatility, it is those oscillations in the market that makes HFT possible. So how can HFT strategies be both the cause and effect of volatility? That would be a paradox and would allow high frequency traders to make an infinite amount of money! The truth of the matter is that HFT makes markets less volatile because they are always there to capture the differences and restore equilibrium in the market.
Another myth is the amount of profits generated by high frequency traders. The typical profit for a single high frequency trade is less than 0.1 cent per share. Based on industry estimates of HFT volume (ten billion shares per day), that is a total of $2 billion per annum in profits, distributed across all the firms who are engaged in HFT. This is actually just a tiny fraction of the profits generated by the investment industry as a whole.
Another myth revolves around technology. Many people seem to think that high frequency traders have an unfair advantage over other investors because of the technology they use. Yes, the technology the HFT firms use enables them to anticipate prices, trade small differences at high speed and thus capture small profits on a consistent basis. But what is unfair about this? Any firm that invests in the required technology and the staff who are able to program the computers can compete at the same level. All it takes is the necessary investment. Since when has investing in technology to give you a competitive advantage been unfair?
Since May 6th, a common misconception is that the "flash crash" was caused by HFT systems. There is absolutely no evidence to support this. In fact, many high frequency traders switched their systems off as the market collapsed, while they evaluated exactly what was going on. When it became clear that there was no earth-shattering news to cause the crash, they switched the HFT systems back on again. That is when the market actually started to recover and return close to its previous levels.
Since stock markets have existed, there have always been two types of participants, long-term investors and short-term traders. If everyone had the same view and wanted to trade the same way, there would be no market. High frequency traders are just the modern-day equivalent of locals, day-traders and specialists who provide a valuable service to the market by providing liquidity. They just make use of technology to enable them to do it faster and more efficiently.
Article Source: FxTradingStock.com
About the Author
If you want to find out more about high frequency trading and high frequency trading misconceptions, a fantastic resource with articles, interviews and detailed explanations can be found at the High Frequency Trading Review website
by: James Underwood
Total views: 41
Word Count: 695
Date: Sat, 17 Jul 2010
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