High Frequency Trading (HFT) became prominent after the ”Flash Crash“ in the U.S. on the 6th of May, 2010. During the “Flash Crash” the Dow Jones Industrial Average plunged about 9% within 20 minutes, drawing attention of the public, regulators, and academia towards HFT (SEC, 2010). Furthermore, the recent financial crisis leads to the fundamental question of whether financial markets in general, and HFT in specific, are serving the real economy. Unfortunately, much of the public discussion referred more to generalizations instead of profound academic results, drawing a blurred image onto HFT. This also resulted in the undistinguished usage of key terminologies commonly used in the field of electronic trading. In our article, we help to lessen these deficits by drawing a distinct picture of how HFT is designed both from a trading strategy perspective and a technological perspective and how it operates in today’s financial markets.
In the first section we will give an overview of the terms Algorithmic Trading and HFT and the business model behind HFT by outlining strategies employed by High Frequency Traders (HFTs) on financial markets. By presenting recent research findings, the third section discusses whether HFT is beneficial to market quality and the section gives an overview on recent regulatory initiatives concerning this concept. Thereafter, technological aspects of this highly demanding business model will be elaborated by discussing three important technological factors in the HFT context: latency, protocols and text mining. Concluding remarks are given in the last section.
Key Terms in this Chapter
Market Maker: A securities market participants who sends buy and sell orders to profit from the spread and / or who has the obligation to ensure market liquidity.
AT: Algorithmic Trading is trading based on a trading technology algorithm that submits, modifies and deletes orders on one or more trading venues exchanges without human intervention.
Spread: Also known as bid-ask spread is the difference between best sell (ask) and best buy (bid) offer in a financial market.
FPGA: Field-Programmable Gate Arrays are integrated circuits which can programmed, these circuits are reconfigurable.
HFT: High Frequency Trading is a trading technology that is characterized by very short holding periods, high trading volumes, frequent order updates and is mostly performed by proprietary traders.
Order Book: List of limit buy and sell orders for a specific financial instrument.