High Frequency trading

intro – trading at high frequency:

High Frequency Trading or HFT is computer algorithm driven trading that quickly adapts to changing market conditions. The idea behind high frequency trading is to reduce the delay between information consumption, decision making and execution. This is done by identifying entry and exit points for trades based on certain trading day conditions and tolerances. For instance, the algorithm may be coded to monitor standard deviation of an index at 5 minute intervals. If this standard deviation is within a certain range, the algo will open a position. Once the index goes below the mean of last 10 “5 minute intervals” price, it should exit the position.

One of the key requirements for application of high frequency trading is high liquidity. At the same time, high frequency trading algorithms are now major contributors to liquidity in the markets. Hence forex, equities and futures markets are the favourite playground for high frequency trading algorithms. Typically, the high frequency trading algos with the fastest execution speeds and closest proximity to trading venues, will be more profitable than traders with slower execution speeds and farther away from the exchange.

It is now virtually impossible for individuals to compete with high frequency trading and day trade profitably. High frequency trading algos, will remove any arbitrage opportunities in milliseconds, before a human being can react to it. The only way to beat high frequency trading is by building a more clever, faster and leaner high frequency trading algo.

A number of brokers are now offering direct API’s that allow individual day traders to build their own algo. STOKAI will provide such high frequency trading algos in the future to individuals.

High Frequency Trading history of high frequency trading

The beginnings of high frequency trading are very humble. As a clerk in his uncle’s bank in Göttingen, Germany, Paul Julius, baron von Reuter met mathematician and physicist Carl Friedrich Gauss, who was conducting trials on electric telegraph, at the time. Reuter, then combined the use of pigeons and telegraph machines to build Reuters news agency.

High frequency trading(HFT), started in the 1930s, in the form of pit traders buying and selling positions at the exchange, and then using telegraph to relay prices to other exchanges. With time, the pigeons and electric telegraph got replaced by the telephone, facsimile and pager. In 1971, NASDAQ was founded as the world’s first electronic stock market. However, initially it was a quotation system without electronic execution. 

Rapid growth in the computer and network technologies in the 90’s brought down the execution time to seconds. Then in 2000’s, execution time came down to milliseconds. High frequency trading became popular when exchanges started to offer incentives for companies to add liquidity to the market. For instance, the New York Stock Exchange (NYSE) has a group of liquidity providers called Supplemental Liquidity Providers (SLPs). These SLP’s attempt to add competition and liquidity for existing quotes on the exchange.

High Frequency Trading market impact of high frequency trading

High frequency trading is a subject of constant debate between the financial markets regulators and members of the industry. From the point of view of Regulators, high frequency trading contributed to flash crashes seen in the markets after 2010. And, they believe that risk controls are much less stringent for rapid fire trades. On the other hand, members of financial industry state that high frequency trading improves market liquidity, lowers volatility, narrows bid-offer spread and makes trading and investing cheaper for other market participants.

In high frequency trading game, the fastest execution wins. And the industry has responded. The execution time is now nanoseconds with specially designed high frequency trading microprocessor chips.

There have been a number of instances of flash crashes and market manipulation since 2010, that have been either wholly or partly ascribed to high frequency trading. 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act passed in July 21, 2010 banned market manipulation tactics like spoofing and layering.

spoofing and layering

Spoofing is a high frequency trading tactic to outpace other market participants and to manipulate the markets. For instance, a large number of limit orders are placed on one side of the limit order book. This makes other market participants believe that there is pressure to sell. This may cause prices to fall because the market interprets the sell-side pressure in the limit order book as a large number of investors who wish to dump the asset.

Layering is then used to scoop up the lowered priced assets with buy order already placed at a lower price. This is then followed by cancels for all previously placed sell orders. A faster HFT algo doing this can cause the slower high frequency trading algo to react to this pattern. This makes the sell orders grow exponentially. The faster algo will then have cancelled it’s sell orders much faster than the slower algo. Hence, slower algo may end up matching it’s sell orders at a lower price. Most likely, because slower algo might have placed sell orders, at a lower price to compete with the faster algo.

Stock Index FX Prediction high frequency trading strategies

statistical arbitrage

Statistical arbitrage at high frequency is actively used when trading liquid assets, like equities, bonds, futures, foreign exchange, etc. There are temporary deviations in asset prices relative to related asset prices in the market. For instance, EUR/GBP rate should be EUR/USD rate divided by GBP/USD. So, you can make risk free profit if there is a deviation between these two values. However, high frequency trading algorithms will execute this within nanoseconds. So, don’t try this at home. In practice, they use similar methods using models of greater complexity involving many more than three securities.

index arbitrage

Index arbitrage works with index tracker funds. These funds have to regularly rebalance company stocks in their portfolio to ensure it reflects the performance of the index. So, they regularly buy and sell large volumes of stocks in line with their changing weights in indices. High frequency trading algorithms are able to front-run these trades if they can anticipate these orders before the fund managers.

ultra-low latency strategy

This is all about speed. This branch of high frequency trading tries to react to news, market data and events faster than the others. It relies on obtaining direct market access and placing and closing orders via next gen telecommunication technology. For instance using microwaves instead of optic fiber will make order execution roughly 25-30% faster.

artificial intelligence

In last couple of years, high frequency trading firms have built AI algorithms that learn from market news. It then predicts which asset prices will move as a result. This strategy consumes news from all sources. Such as twitter, facebook, linkedin etc in addition to the traditional sources like Bloomberg and Reuters.

Stock Index FX Prediction you against high frequency trading?

Most retail traders, especially new market entrants, read about high frequency trading and get disheartened. They ask – “what is the point of trading if I can never beat an HFT”?

Well, there are two important considerations here.

Firstly, HFT’s provide a lot of liquidity in the markets. This allows you to trade at any time of the day and still get good bid-ask spreads. This makes trading cheaper for you in the long run. It also means you can enter and exit a position when you want to. As you almost always have a willing party to trade with. Also high frequency trading algorithms tend to work in very short timeframes. It’s very much a quick in and out operation. If you tend to keep your position open for more than an hour, you are not competing with high frequency trading. In fact, they are helping you with narrower spreads and high liquidity.

Secondly, within the next decade it is possible, that there will be new technology that will allow you to compete with HFT. If you have a maths and computing background, you can do this today. There are broker platforms that allow you to write your own algorithm. This will only get faster and cheaper with time.

Stock Index FX Prediction final remarks

Trading is a zero sum game. It’s a competition. And, like any competition, you need to know what you are up against. While high frequency trading may look like this fast, big beast, it has it’s strengths and it’s weaknesses.

It’s strength is speed. While it’s weakness is a very narrow view of the market. It’s strength is no emotions when trading. While it’s weakness is not being able to read between the lines.

If you are driving down a single carriageway and a large lorry is coming straight at you in your lane. Do you stay in that lane or swerve across to the empty lane where you are not supposed to be? The rules are clear, you are not supposed to be over there. The system says don’t do it, but reality is an 18-wheeler coming toward you in your lane. Do we follow all the rules of safe driving? Or, do we adapt to the situation at hand? Reality rules. On the road, and in the markets.

The first rule of life is to survive. The second rule is that all rules can be broken for the first rule. Take this as your trading philosophy. This means no matter what process, strategy or data you have, always watch what is going on in front of you. That is what our brain is for, to observe, to record, to note changes, and then to develop an optimum use of the system.

Stock Index FX Prediction so what next?

STOKAI does a lot of the work for you. And gives you the power to make decision based on fundamental analysis of the markets. We have a vision for this to become high frequency trading algorithm of the future. And we really hope that you will join us on this journey.

STOKAI provides daily prediction using algorithms based on all factors that impact commonly traded assets. Then, it evolves the forecast over 10 days in the future. Tutorial and brief user guide is available here – Tutorial. If there are any issues, questions or ideas, please contact our customer services team.

High Frequency Trading

Stokai is a product of Rumble Horse Tech ltd. A company registered in England.