What exactly is high frequency stock trading?
High frequency stock trading is is an automated trading platform which utilizes powerful computers to transact a large number of orders at extremely high speeds. These high frequency trading platforms allow traders to execute millions of orders and scan multiple markets and exchanges in a matter of seconds, thus giving the institutions that use the platforms a huge advantage in the open market.
Issues involved with HFTs
Legal Regulations
DCM Requirements - include pre-trade controls on maximum order message and execution frequency per unit time, order price and maximum order size parameters, as well as order cancellation systems
- Compliance reports - DCMs must periodically review the compliance reports, identify outliers and provide instructions for remediation
- Test environments - must be supplied by DCMs, and must include the ability to test compliance with risk controls and order cancellations
- DEA orders - must be established and FCMs must be required to use them
Controversy - Are HFTs ethical?
HFTs can be used unethically they can be used to place fake orders that draws attention towards the target market and other traders would buy into these areas and they take out their orders.
There is also the criticism that small investors don’t have the resources to compete against the HFT devices.
Another unethical reason that people are against them is that they have the potential of causing a market crash.
Competition
Flash Crashes / Market Crashes
- The first flash crash occurred on May 6th 2008. What happened was the HFT algorithms were selling and buying large volumes but without the net price so they weren’t making money. In four minutes the price of the market went down by 3%. Then later in, the devices stopped completely as they had a limit of a maximum amount of money that they can trade, so when they reached the limit they had sold and bought a lot but all they did was lose significant money, as no net price was recorded.
- In 2010 the American stock market fell 10% in a matter of minutes and blue-chip investors (the big ones) stocks were able to be bought and sold as little as one penny, and almost recovered by the end of the day. This was initially caused by a large sell order on the S&P 500 market which took place over 20 minutes. HFTs soon followed by buying stocks and selling them almost immediately due to their algorithms, leading to the crash. Most HFTs got shut-down during this crash as the largest flash crash by HFTs in the history of the stock market.
- In 2012, the largest HFT trading firm Knight Capital (which accounted for 17% of all HFT sales in NYSE and 16% in the NASDAQ) had a bug that caused them to aggressively buy 140 stocks worth $7 billion in total. Once they fixed it they had lost $440 million total, which was 40% of their company’s worth, crippling the company.
- The 2013 flash crash was caused by a fake tweet that said Obama was caught in an explosion. The high capabilities of the computing algorithms of the HFT actually reads news on the internet to see what they should be trading in. They do that by searching for keywords in this case ‘white house’, ‘obama’ and ‘explosion’ this caused 130 billion loss in stock value in a matter of seconds but this was recovered quite quickly.
Bugs, bad AI
Industry averages are 15-50 coding errors per thousand lines of code, and trading software averages between hundreds of thousands to a few million lines of code. These bugs normally only show up in edge cases but can lead to millions of dollars in loss of money as shown by flash-crashes.
Bugs can be bad for HFT as if the bug is big enough or complex enough it can ruin the entire trade, and possibly stop all trading which can result in massive loss of revenue for that day of trading for the company.
One bug that occurred resulted in a company to aggressively buy $7 billion worth of stocks over 45 minutes, which was about $2.6 million a second. Whilst trying to recover that money, they ended up losing $440 million overall as the bug also sold the stocks for a lower price, which was about 40% of the company's value beforehand.
Competition
There is fierce competition between HFTs as they try to buy and sell stocks on the markets. In 2010 HFTs accounted for 60% of all trading on US stock markets.
Because of how HFTs operate, more traditional stock traders lose out on the money being made by the high speed of the HFTs.
Who are the Key Stakeholders in HFTs?
There are many stakeholders involved with HFTs.
All those who have stocks in the stock market who have their stocks being traded by HFTs, businesses who run HFTs, stock brokers in competition with HFTs.
Basically all of Wall Street and the rest of the world who trade on the stock market and those affected by the stock market are affected by HFTs.
All those who have stocks in the stock market who have their stocks being traded by HFTs, businesses who run HFTs, stock brokers in competition with HFTs.
Basically all of Wall Street and the rest of the world who trade on the stock market and those affected by the stock market are affected by HFTs.