An insider’s look at the new high frequency phenomenon that is transforming the investing world
Written in 2011 by Edgar Perez, American author and entrepreneur, this book has become an international reference on High-Frequency Trading (HFT), financial regulation and international economics. In his book, published by McGraw-Hill Inc., Dr. Perez explains us the use of sophisticated technological tools and computer algorithms to trade securities on a rapid basis, as well as its impact on financial markets.
“Speed traders have been called many things—from masters of the universe and market pioneers to exploiters, computer geeks, and even predators. Everyone in the business of investing has an opinion of speed traders, but how many really understand how they operate? The shadow people of the investing world, today’s high-frequency traders have decidedly kept a low profile—until now.“
Indeed, since the early 2000′s, electronic trading has expanded in every major stock market platforms, taking a significant part of the daily volume exchanged, especially in highly liquid markets. In June 2010, HFT reached up to 58% of the total daily volume exchanged on the global Foreign Exchange Market. Nowadays, we cannot consider popular trading platform without the presence of HFT, seeking short-term anomalies and market imperfection.
Low latency trading, robot trading, high-speed trading, are all terminologies to describe the principle of entering trading orders on a financial electronic platform by an automated algorithm, mostly computed inside the proprietary trading division of large investment banks or hedge funds working on algorithmic strategies, such as M3 Capital, Citadel holding or Infinium CM.
Since the multiplication of critical events such as the flash crash of May 2010, 6th -when the Dow Jones index lost 600 points in less than 10 minutes- or more recently the USD440 million loss of Knight Capital hedge fund in August 2012 -due to an algorithmic issues inside one of its algorythmic models (black-box)- many concerns have been raised toward it. Hence, HFT’s “predatory” and “unfair” practices have been pointed out. The SEC (US Security Exchange Commission) has undertaken numerous investigations about trading activity and published many public reports and concerns towards the “potential” negative impact on the financial market HFT may cause.
Paul Krugman, Nobel Prize in economic sciences in 2008, wondered about the “social utility” of automated algo-trading. In his paper “The Theory of Interstellar Trade” released in 2010, Krugman was surprised by the popularity, as well as the exponential growth of speed trading across numerous financial markets. Its paper describes high speed trading methods through automated book orders and explained in some extents the large profit of HFT main players, supported by empirical studies on Goldman Sachs and JP Morgan proprietary trading desk over the 5 previous years.
“It is crucial to remember that markets exist for specific reasons. The two primary reasons are capital formation and risk management. After things like the “flash crash”, it is questionable whether the capital formation function is healthy. Electronic trading has killed the effectiveness of the coffee market in NYC,” explained Krugman in the New Post (2010).
In his paper, Krugman defined the stock market 1st goal as allocating capital to the most productive utilization, such as helping firms with smart ideas to raise funds, but market makers “with booking orders 30 milliseconds faster than others” through more sophisticated trading tools might not lead to the improvement of its primary social duty.
HFT will no doubt play an ever larger role as computer technology advances and the global exchanges embrace fast electronic access. The Speed Traders explains us everything there is to know about how today’s high-frequency traders make millions—one cent at a time.