High Frequency Trading: Take a Look and Cut the Line

Latency arbitrage, electronic stock trading, and high-frequency trading are the financial jargon that has been regularly discussed in the past month. People claim that the US stock market is fixed; by high frequency traders, investment banks and private stock exchanges. But what does all that mean?

Public and private exchanges contain high-performance computers that are programmed to trade financial vehicles at the speed of light. Each computer trades large chunks of stocks in fractions of a second, simultaneously receiving information about the same stocks, milliseconds before regular investors receive the data. High-frequency trading companies collect data just milliseconds in advance, so what’s the big deal?

The concept of latency arbitrage is surrounded by the idea that people receive market data at different times; the disparity in time is minuscule. Latency arbitrage occurs when high-frequency trading algorithms make trades a fraction of a second before a competing trader, then broadcast the stock moments later for a small profit. While the profits per trade are small, the aggregate income from HFT is a sizeable portion of the wealth traded on the US stock market. Essentially, latency arbitrage is the cutting edge theme of HFT – Algorithmic Trading, which specifically uses sophisticated technological tools and computer algorithms to trade securities quickly.

Today, we find private exchanges paying large sums of money to run high-speed fiber optic cables from trading venues directly to their servers, slashing the time they receive market data by milliseconds.

Here’s an illustration of how high-frequency trading firms exploit multiple stock time frames in a single trade: You buy 20 shares of Bank of America at $17.80147. You place the order through your online brokerage. The broker buys 5 shares from an investor in Chicago, 5 from a firm in Los Angeles, and 10 from one in Denver. The brokerage then sends your order via high-speed fiber optic cables to parties in Denver, Chicago, and Los Angeles. As soon as your order arrives in Denver, companies that have wires directly connected to that exchange will see your potential order, and within 4 milliseconds of you buying 10 shares of Denver and 5 shares of Chicago, high-speed trading companies sell Bank of America stock. to you at $17.80689 and an even higher price by the time your order arrives in Los Angeles. Companies use various manipulations, as such on a large scale for investors and companies across the country.

Companies like the Royal Bank of Canada have developed software that staggers an operation to allow each party involved to receive the information immediately. Which means (in the context above), your order to buy Bank of America will arrive in Chicago, Denver, and Los Angeles at the same time, leaving not a nanosecond for high-frequency merchants to fill your order. Other commercial firms such as Fidelity have installed 80-kilometre spools of fiber optic cables between themselves and other merchants. The coil serves to delay the operations that enter and leave the company. When high-frequency operators submit their operation to Fidelity, their data travels over optical cables for a full 50 miles and arrives at the operator at the same time as all other operations.

Essentially, the companies that have the financial wherewithal to move to the front of the line to trade do so. These companies are ambivalent about what they are negotiating; They trade because they know they are guaranteed a profit. High frequency traders are not playing the market, they are playing the players. HFT has since its inception been the domain of mathematicians and physicists. The mere idea of ​​physicists having their own niche in stock market trading should draw attention on its own. These traders are not actually investing capital; they are collecting what is essentially a tax from each share of stock that is traded. Unfortunately, it’s legal… and strangely enough, the big banks aren’t worried about it. Simply put, all they have to do is put themselves on the same plane as high-frequency traders, which would include trading algorithms that stagger each trade or reels of high-speed fiber optic cables that physically combat the speed at which they trade. all parties receive data. .

Ultimately, the latency arbitrage form of high-frequency trading is legal, but it’s certainly not victim-free anymore. All investors who do not have the same trading facilities as high frequency traders are forced to pay a marginally higher price. On the one hand, the companies that got involved in HFT paid large sums to do so, which lends merit to the notion that it is the prerogative of each company. Also, arbitrage has been a concept used by traders since the creation of the New York Stock Exchange. On the other hand, investing in the market is a fundamental aspect of our economy and the stock market plays a fundamental role in the growth of industries respectively. Investing in the stock market is one of the few truly win-win activities for the individual (minus the inevitable implementation of capital gains tax). Complexities like HFT in the market discourage an exchange powered by the invisible hand on which the platform of our economy exists. I think once the disincentive beyond taxes is allowed, general participation [in the market] decreases All inverters must operate in the same plane: the investment evaluation does not include the security analysis, the quantitative and qualitative analysis or the location of the high-speed fiber optics. As soon as algorithmic trading is no longer one-sided (like merger arbitrage), it should be regulated by an appropriate government agency. Ironically, the way to preserve the rudiments of laissez-faire economics is to employ the considerable powers of legal action by promoting regulation.

As of April 13, the Securities and Exchange Commission is preparing to remove a number of high-frequency trading companies. Additionally, the SEC seeks to employ a campaign of new business rules and practices that would limit latency arbitrage.

Finally, some food for thought: the practice of high-frequency trading [at its current level] It was devised by Bernie Madoff.