Types of high frequency trading strategies
As a youngster, I was acutely aware of many differences between the life I had and the one my friend Steven AKA the rich kid had. In the aftermath of Michael Lewis' book "Flash Boys" there has been a renewed surge in interest in High Frequency Trading. Alas, much of it is conflicted, biased, overly technical or simply wrong. And since we can't assume that all those interested have been followed our 5 year of coverage of a topic that finally has earned its day in the public spotlight, below is a simple summary for everyone. To be sure, the thinking behind HFT is hardly revolutionary, frequency even new. Although today HFT is closely associated with high speed computers, HFT is a relative term, describing how market participants use technology to gain information, and act upon it, in advance of the rest of the market. Near the advent of the telescope, market merchants would use telescopes and look out to the sea to determine the cargo hold of incoming merchant ships. If the merchant could determine which goods were soon to arrive on these ships, they could sell off their excess supply in the market before the incoming goods could introduce price competition. That said, the real proliferation of technology in trading, started in earnest in the s with the arrival of the NASDAQ, the first exchange to heavily use computers. Ironically, while some form of HFT has been around for a long time, its true "potential" was first revealed in October with the first whole market flash crash, which resulted from an exponential propagation of program trading, which like right now types HFT, nobody truly understood. The rough chronology of algorithmic trading, of which HFT is a subset, is shown in the timeline below. Over the past decade, following regulatory initiatives aimed at creating competition between trading venues primarily as a result of the overhaul of the National Market System Regulation or reg NMSthe equities market has fragmented. Liquidity is now dispersed across many lit equity trading venues and dark pools. This complexity, high with trading venues becoming electronic, has created trading opportunities for technologically sophisticated players. For traditional investors, however, these new market conditions are less welcome. Institutional investors find themselves falling behind these new competitors, in large part because the game has changed and because they lack the tools required to effectively compete. The role of the human trader has evolved. They must now also understand how various electronic trading methods work, when to use them, and when to be aware of those that may adversely affect their trades. Market venue competition began with the Alternative Trading System regulation of This was introduced to provide a framework for competition between trading venues. These regulations were intended to promote efficient and fair price formation in equities markets. As new venues have successfully competed for trade volume, market liquidity has fragmented across these venues. Market participants seeking liquidity are required by regulatory obligations to access visible liquidity at the best price, which may require them to incorporate new technologies that can access liquidity fragmented across trading venues. These technologies may include routing technology and algorithms that re-aggregate fragmented liquidity. Dark Pools — trading platforms originally designed to anonymously trade large block orders electronically — began to expand their role and trade smaller orders. This allowed dealers to internalize their flow and institutional investors to hide their block orders from market opportunists. The use of these technologies can lead to leaking trading information that can be exploited by opportunistic traders. Information is leaked when electronic algorithms reveal patterns in their trading activity. These patterns can be detected by HFTs who then make trades that profit from them. Competition for liquidity has encouraged trading venues to move from the traditional utility model, where each side of a transaction would be charged a fee, to models where the venues charge for technological services, pay participants to provide liquidity and charge participants that remove liquidity. Many trading venues frequency become technology purveyors. Broker-dealers have realized that they are often the party paying the trade execution fee, which is used by the venues to pay opportunistic traders a rebate for providing liquidity. To avoid paying these fees and internalise their valuable uninformed active flow, especially from retail customers, broker-dealers have also established dark pools. By internalising their flow or, in many cases, selling it to proprietary trading firms, they can avoid paying the trading fees that the venues charge for removing liquidity from their order books. The irony is that in their attempt to streamline and simplify the market with Reg ATS and Reg NMS, regulators have created the ultimate hodge podge of trading venues, information leakage nodes, and countless opportunities to frontrun both institutional and retail order blocks. Before we continue, let's take a look at perhaps the most critical and misunderstood concept around, one which HFT advocates are quite happy to ab use without really understanding what it means. Implementation Shortfall IS Costs — comprised of 2 pieces: Timing Delay Costs - Any delay cost incurred between the Initial Decision Open on Day 1 and the Broker Placement Price. Think of this as the cost of Seeking Liquidity; and Strategies Impact Costs - Price change between the time the Order is placed with the Broker and the eventual trade price. Why is liquidity so critical? Because it goes hand in hand with the concept of the modern exchange, since the measure of consummated liquidity is a key variable in determining the successfulness of any trade venue. It also goes to show why HFTs never operate in a vacuum but in explicit symbiosis with exchanges. It is this inextricable link between the venue and the algos that dominate the venue, that has led many to suggest - correctly - that one of the key culprits for HFT proliferation is trading dominant exchange business model, known as the High model, in which the liquidity provider is paid in practical terms it means paying those who provide liquidity with limit orders even it the limit orders are merely "flashed" subpenny orders frontrunning a major order blockwhile charging liquidity takers those who take high liquidity with market orders. This is summarized in the panel below. The playing field has been tilted in favor of HFTs, who use high speed computers, low-latency connectivity and low strategies direct data feeds to realize hidden alpha HFTs can follow active, passive or hybrid strategies. They do this efficiently across many stocks simultaneously by utilizing the full potential of their computer hardware, venue-provided technology and statistical models. This strategy is commonly known as Electronic Liquidity Provision ELPor rebate arbitrage. These ELP strategies can also be signal detectors. An HFT can then use this information to initiate an active strategy to extract alpha from this new information. Active HFTs monitor the routing of large orders, noting the sequence in which venues are accessed. The HFT will close out their position when they believe the large order has finished. The result of this strategy is that the HFT has now profited from the impact of the large order. The concern for the institutional investor, that originally submitted the large order, is that their market impact is amplified by this HFT activity and thus reduces their alpha. The most sophisticated HFTs use machine learning and artificial intelligence techniques to extract alpha from knowledge of market structure and order flow information. The ubiqituous presence of HFT also means that one of the key considerations when placing an order is "smart order routing" which take frequency account such concepts as trading arbitrage and order size. This is furhter simplied in the panel below. Which brings us to the topic of whether all HFT does is simply frontrunning, legal as trading may be, and allowing firms like Virtu to post "liquidity providing","trading" profits on 1, of 1, trading days. The answer - no. At least not explicitly. The full list of HFT strategies, broken down by their impact on various stakeholders is shown below. Again, at least on paper, some strategies are beneficial if mostly to the retail investor. The biggest question, however, is - is there such a thing as a retail investor left at a time when market trading volume has fallen to decade lows, and where HFT now comprises the bulk of lit volume. And while on paper HFT does provide benefit, the reality is that in practice the consequences of HFT are almost unique negative. Putting types the ethical implications of whether one views frontrunning as legal or not, the far bigger unintended consequences of HFT is that it has made trading venues inherently far more unstable and prone to sudden and unexplained crashes. In some cases, these events resulted from the unpredictable interaction of trading algorithms; in other cases they were the result of software glitches or overloaded hardware. A software malfunction from Knight caused waves high accidental trades to NYSE-listed companies. The SEC later launched a formal investigation. An internal system upgrade resulting in technical glitches impacted options on stocks and ETFs, leading to erroneous trades that were vastly out of line with market prices. Goldman Sachs stated that it did not face material loss or risk from this problem. Due to a connection issue NASDAQ called a trading halt for more than three hours in order to prevent unfair trading conditions. An error during the transferring of data caused the NASDAQ Composite Index to be frozen for approximately one hour. Some options contracts linked to the indexes were halted, though no stock trading was impacted. NASDAQ officials state that the problem was caused by human error. Although the market suffered no losses, this technical malfunction — the third in two months — raises considerable concerns. Which brings us to the culmination of 50 years of changing technology, namely the changing investor-broker relationship. High, investors types their efforts seeking alpha and brokers types charged with sourcing liquidity. Liquidity could be sourced via the upstairs market or the stock exchange. The stock exchange operated as a utility that consolidated liquidity. Beyond generating alpha, the only decision for an investor was choosing a broker to execute their trades. Today, investors are still concerned with generating alpha. However, the trading process required to execute their alpha strategies has become more complex. The consolidated utility model has been replaced by a market that is highly fragmented with for-profit venues vigorously competing for liquidity which is provided primarily by HFTs. This new environment puts brokers in a difficult position. They have a fiduciary responsibility to provide best execution to their clients. This requires them to invest in new technology to source liquidity and defend against HFT strategies. And because many of these venues now pay rebates for liquidity, which is quickly provided by HFTs, brokers are usually left having to pay active take fees to the venue. And at the same time that brokers are incurring these costs, investors are pressuring them to reduce commissions. By accessing venues with lower trading fees, or attempting passive order routes of their own, brokers can reduce their operating costs. However, these trade routes are not necessarily best for the investors. Sophisticated investors now demand granular execution information detailing how their order flow was managed by their broker so they can ensure they are receiving the best execution. While brokers provide aggregate performance reports, investors can build a more complete analysis, including broker performance comparison by using more granular trading. So putting it all together, what is the current state of the market? Ironically, when one strips away all the bells and whistles of modern technology, it all goes back to a concept as old as the first market itself - namely alpha, or outperforming the broader frequency. In order to find hidden alpha, it is important to first understand where market participants are with respect to information utilization. Taking advantage of the information opportunity, and finding hidden alpha, requires a firm to move up the stages of adaptation. This measures the sophistication of the use of information in directing action. Whether the information is trade data or newsfeeds, it can be put to use in more or less sophisticated ways, from simple arithmetic to complex statistical methods coupled with strong strategic understanding. Arithmetic uses aim at providing no more than basic accounting measures of values, volumes and gains and losses. Statistical methods aim to identify types in information that can high used to guide trading. Strategic understanding introduces game theory, anticipating the reaction of other market participants when an investor employs a particular trade strategy. Each trade an investor makes provides an opportunity to learn. Gathering information from every trade, as opposed to a select few, helps give the investor a better understanding of how those trades may perform in the future. The more frequent the analysis, the more relevant the findings will be. Findings serve a purpose only if they are acted upon. The key is to use information to guide actions whose outcomes are then analyzed and the findings reapplied. Frequency creates a continuous iterative loop that drives towards ever greater efficiency. Knowledge sharing with similar objectives e. Working together, institutional investors strategies share block order implementation experience and data, as a utility. The result of this could help participating institutional investors defend against market impact losses and protect proprietary strategies. For institutional investors, their proprietary intellectual capital usually lies within their investment decisions, not their trade implementation routes. Institutional investors frequency thus more willing to collaborate with eachother to work against trade strategies frequency cause them market impact. So the bottom line: HFT is legal frontrunning In fact, like the TBTF banks, HFT itself has become so embedded in the topological fabric of modern market structure, that any practical suggestions to eradicate HFT at this point are laughable simply because extricating HFT from a market - which indeed is rigged but not only by HFTs at the micro level, but more importantly by the Federal Reserve and global central banks at the macro - is virtually impossible without a grand systemic reset first. Which is why regulators, legislators and enforcers will huff and puff, and Because if there is one thing the TBTF systemic participants have, is unlimited leverage to collect as much capital due to being in a position of systematic importance in a market, rigged or otherwise. These companies have to be fools to put billions on the line for this software mania when we've seen that they have problems getting Excel formulas correct. My silver coins look so nice, so simple, such a bargain, no HFT worry, no counterparty risk, no Tums and sleepless nights. This is the obvious result of capitalism. That all you can do. Ok it's frontrunning, scalping trades a few pips up to a few cents when trades pass the HFT on their high to the exchange, I get that. And it's just at-market orders not range-bound orders my termsI get that. And it's done in a few milliseconds so it's not noticed in time stamps, I get that. I'm not dumb, show me an electrical schematic, give me a couple minutes with it, and I can tell you what you wana know about it. And it's nothing compared to humongous overt frontrunning Fed lets PDs do and trillions in bailouts and all that. This part is not academic: That definitely affects you even with zero trades in the system. And what's the difference between HFT and front-running again? Oh yeah, HFT is still legal. Thanks Eric dick Holder. Love the tempo and badass bass on that song: Nobody uses congas anymore. Or such bold sounding guitars either! So the bubble grows larger and larger, no one but business scalping business, it sails away in to the distance taking what we laughingly call money with it. I mean come on billionaire what is that about. Piece of shit day traders getting ripped off by even bigger pieces of shit HFT front running scalpers. Both of high guys are the retailer investors enemy, so let them have at each other. Really good entertainment seeing them trying to pickpocket each other. Even that zany E-mini crowd gets a goo ass raping from them divine HFT putas. Types are the right had of god, They are the trading hand, They are the fat finger, and "FLASH CRASHES" are not mistakes, they are an intentional gutting of of allocation traders working one minute tick with stupid stop loss contrived trading models. Buy or sale at market, well do ya, punk?. Them HFT shops don't need to go go throgh no high broker brpker, HFT operators don't seed no farking SEC ticket. HFT get to sift through the entire farking order queue. They don't pay no farking broker fees or execution fees. They can can flush the FX market in a nano, and then price up the ask at next nano. It's not about transaction fees or taxes - strategies is all about the dominion acquired through a co-located pipe - and dat all it be! What should the sign be on all equity, FX, futuresm and options exchanges? It's a suckers game, more etucal to bet on the outcome of a dog or cock fight than the price moves in paper that gas no value! All you need to know about HFT: People making billions by performing no useful function for society. Tyler gives it out for Free If ZH keeps up the critical analysis there will be a time that ignoring ZH will become completely impossible. In order to learn something worthwhile here, you'd better put on appropriate headgear. Yes, Strategies am talking tin-foil, but to be honest, for best results it should at least be a massive Rhenium-hat. Long live the free market! We don't need them as the free market will sort things out for the best. I have three businesses and have notified Fidelity that unless they change there order flows I will take away there k and payroll business with us. PS TD Ameritrade has also been put on notice by me personally. Shame on them both. I'll make it even simpler. It is insider trading. No different than a land speculator being tipped off to where the highway interchange is going or the next metro station, and buying up the strategies to sell to the uninformed for a profit. So when liquidity makers can generate profits based on trades, they are no longer providing liquidity, they are generating profits. Here's our Cookie Policy. How to report offensive comments. Home Contributors Newsletter Donate More Store ZH-TShirt Glossary Archive Manifesto RSS. Mueller Investigation Is Pretext To Impeachment by ZeroPointNow - Jun 17, 7: What Rich Used To Be by Tim Knight from Apr 7, 9: No matter the reason, one thing is certain: NASDAQ — DATA TRANSFER PROBLEMS FREEZE INDEX FOR 1 HOUR An error during the transferring of data caused the NASDAQ Composite Index to be frozen for approximately one hour. Summarized visually - Before: Oliver Wyman, Hidden Alpha in Equity Trading. Printer-friendly version Apr 7, 9: Comment viewing options Flat list - collapsed Flat list - expanded Threaded list - collapsed Threaded list - expanded. Date - newest first Date - oldest first. Select your preferred way to display the comments and click "Save settings" to activate your changes. SmilinJoeFizzion Apr 6, 4: Oh wait, I'm the fool. I forgot they're TBTF. Drifter negative rates Frequency 6, 5: Gosh, it's all so complicated, way above my head. Buy what Wall Steet hates. Or say they hate. Doesn't matter, it's a bargain. Oh regional Indian lordylord Apr 7, 9: In this simple TLDR piece, I found the last lines disturbing. Now they are such a big part of the flow that yanking them would kill the market? Nice, wait till trading silent predator becomes types symbyote and then declare it bad. So, now, when one dies, the whole thing dies. Thats a compliment by the way. Drifter nmewn Apr 6, 8: Yea, it really is nmewn. But those charts make my head swim. And I really don't care, I'm not in those markets. I just don't care about this HFT stuff, not even academically, it doesn't affect me. Btw, how did you come up with that strange handle? I can't even pronounce it. Problem Is Drifter Apr 7, And it does affect you MeelionDollerBogus Drifter Apr 10, Cattender SmilinJoeFizzion Apr 6, 5: Until the middle class loses half of their wealth again and then beg for MORE government. Kirk2NCC SmilinJoeFizzion Apr 6, 8: How about "iRobot futures" or "Soylent Green futures"? Personally, I'm going long on "Guillotines futures" and short on "iBanker futures". More than "haircuts" or "close shaves" may be eminent during the Big Correction. Since we're being funny Oh regional Indian blindman Apr 7, 9: Mr Giggles Apr 6, 5: Summary of it all: The whole, and every market, is contolled by W. I think they can sum this up really easy: HFT all you need to know Piece of shit day traders getting ripped off by even bigger pieces of shit HFT front running scalpers. Cadavre gimme-gimme-gimme Apr 6, 6: THey can cancel "sniff 1em out" orders, on a dime, and reorder without batting a farking eye! Stuck on Zero gimme-gimme-gimme Apr types, I Write Code Apr 6, 5: Just come to ZEROHedge and get it? Absolutely the BestTyler! Your ship has arrived on the world stage Seeking Aphids centerline Apr 6, 9: Philalethian Seeking Aphids Apr 7, 3: Family and world community Grace and gratitude for all you ALL express in the good written works here on ZH. Seeking Aphids Apr 7, 3: I m here to learn about what will happen in the future. Can't find a better source. Bearwagon Bankstein Swissgoldberg Apr 7, 3: All you ndeed to know is that if you are a trader outside a HFT operation, the market is rigged. Drifter dbTX Apr 6, 6: All you need to know: It's a big rich club and you ain't in it. Philalethian dbTX Apr 7, 3: Who profits from war? Ban KKiller Apr 6, 5: Criminals strategies always rationalize their reasons for crime. At least I do Solarman Apr 6, 5: Just faster, in smaller amounts, and more frequently. RaceToTheBottom Apr 6, 5: Who ever designed that system needs to be shot. Perhaps Vietnam would be kind enough to offer the U. RaceToTheBottom strategies Apr 7, 7: Create new account Request new password. To prevent automated spam submissions leave this field empty. Zero Hedge Reads Acting Man Alt-Market Benzinga Boom Bust Blog Capitalist Exploits China Financial Markets Chris Martenson's Blog Contrary Investor Daneric's Trading Waves Dr. New Comments Standing on the shore, Caleb Abell. You're the only one being SummerSausage. The cab industry is a perfect TGDavis. Because something, a Oxygen. Uber, where the costs are praxis. Anyone notice that when Comey Joebloinvestor. Attorneys In DNC Fraud jamesmmu. This piece trading even rise Bernardo Gui. How to report offensive comments Notice on Racial Discrimination. Strategies News AUDIO CLOSED FOR THE WEEK, THE DESK WILL REOPEN ON SUNDAY AT BST Subdued end to the week, stocks mixed, USD down. Fitch Revises Portugal's Outlook to Positive; Affirms at ' CenturyLink CTL moves lower following reports of a sales scheme WTI crude futures settle at USD DBRS affirms the UK at AAA; stable trend. Costco COST downgraded from buy to neutral at Goldman Sachs. Sees a modest recovery in growth over the Apollo Global management to meet with Oppenheimer. Frequency Trump's policies moved stocks. Impinj jumps types Amazon-Whole Foods announcement, Barron's says. CAS Medical receives deficiency letter from Nasdaq. LifePoint enters into trading plan. Perficient backs Q2 adjusted EPS view 29cc, consensus 29c. Cobalt International Energy's CIE 1-for Reverse Stock Split to be Effective After the Close Today. Brookfield Infrastructure Partners BIP Announces Resignation of Rafael Miranda from Board. 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