Monday, April 21, 2014

HISTORY OF High Frequency Trading

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US market regulator, the Securities and Exchange Commission (SEC) allowed the first HFT trade in 1998. Now, almost 60-70% of equity trading volumes in the US is an HFT. According to Bank of England, HFT trades in Europe reached 40% of equity order volumes, and in Asia, it ranges between 5-10%. Getco, Knight Capital, Jump Trading, and Citadel are one of the largest HFT trading firms in the US.

 


What Are The Basic Rules For An HFT Trader?


The odds of going wrong can be as high 6 out of 10 times, but profits earned on right trades multiple many times higher compared with the loss incurred on wrong trades. As a result, Sharpe ratio, a measure of return adjusted for risk, is significantly higher than the traditional buy/sell strategy.




Why Are HFT Traders Under Regulatory Lens?


Globally, market regulators believe that HFT traders bring excessive volatility in the markets, and pose serious risks to the financial system. While analysing the reasons for the flash crash that occurred in May 2010, the US SEC concluded in its report that the action of HFT traders contributed to volatility. HFT traders are levied charges for benefiting from the index re-balancing by mutual funds. For instance, on account of market capitalisation adjustment, if a stock is moving in or out of the index, the algorithm provides for a projection of the expected stock price movement on the basis of an institutional order-book leading to really handsome returns. Italy was the first country to introduce a levy of 0.002% charges on an equity transaction which lasts less than 0.05 seconds.


WHAT DOES AN HFT TRADER BRING TO MARKETS?


An HFT trader acts as one of the most important market-makers and brings down the spread between the bid and ask prices. For instance, if the bid price of any security is 100 and ask price 101, the HFT trader will try to place an order at Rs 100.05 for bid and Rs 100.95 for an ask quote. This action leads to the execution of the trade.

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