High Frequency Trading (HFT), also known as automated trading, algo trading, black-box trading, whitebox trading, or robo trading, is the use of electronic platforms for entering trading orders with an algorithm deciding on aspects of the order such as the timing, price, or quantity of the order, before human traders are capable of processing the information they observe. HFT firms account for 73% of all US equity trading volume. HFT is widely used by pension funds, mutual funds, Hedge Fund, Big Banks like Goldman Sach and other buy side (investor driven) institutional traders, to divide large trades into several smaller trades to manage market impact, and risk. High-frequency trading has taken place at least since 1999, after the U.S. Securities and Exchange Commission (SEC) authorized electronic exchanges in 1998. At the turn of the 21st century, HFT trades had an execution time of several seconds, whereas by 2010 this had decreased to milli- and even microseconds.
With increase competition and low volume participation, the chances of crash only increases with time. For single penny gain, every HFT tries to compete with each other.
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| High Frequency Trading has caused 10 known flash crash in last 3 years. |
"Some marketplaces, like NASDAQ, offer high-frequency traders a peek at orders for 30 milliseconds - 0.03 seconds - before they are shown to everyone else. This allows traders to profit by very quickly trading shares they know will soon be in high demand. Each trade earns pennies, sometimes millions of times a day." - The Thirty-Millisecond Advantage, The New York Times.
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| Thirty Millisecond Gives HFT advantage over slower trader. |
Below is the list of software glitches that moved the market downside:
1. On February 3, 2010, Infinium Capital Management's high-frequency trading system caused a dollar spike in oil prices. The algorithm was turned on four minutes before the market closed, and uncontrollably began placing 2,000 to 3,000 oil futures orders per second. The firm lost $1.03 million in five seconds.
2. On May 6, 2010, stock prices fell for a terrifying 20 minutes. The Dow Jones Industrial Average was even down 998.5 points, erasing $862 billion. But, a few minutes after the crash, stocks regained about 600 points. The CFTC blamed the mutual-fund company Waddell & Reed Financial for setting off the chain of events with its E-mini futures trades.
3.In February of 2011, high-frequency and algorithmic trading, made the sugar market crash by 6% is just one second.
4. In March of 2011, cocoa-future prices on the Intercontinental Exchange dropped 13% in just seconds.
5. Five days after Japan's devastating earthquake and tsunami, on March 16, 2011, in one of the yen's biggest moves in history, the dollar fell to 76.32 yen from 80 yen in the span of minutes.
6. On March 31, 2011, 10 of Morningstar's 15 new FocusShares ETFs experienced a "flash crash". Within the first 30 minutes of trading, the ten ETFs lost anywhere from 25% to nearly 100% of their value. Market maker Knight Capital was blamed for the error, admitting that they experienced a processor error in their computerized trading platform.
7. On March 23, 2012, BATS Global Markets, a stock exchange based in Kansas, went public on the Nasdaq. BATS decided to withdraw their IPO after shares plunged from $16 to $.04 per share.
8. On May 18, 2012, in the biggest IPO in internet history, Facebook shares were listed on the Nasdaq.
9.On the morning of August 1, 2012, about 148 stocks experience an unknown surge in market volume. Market-maker and broker, Knight Capital Group, was responsible for the mess and blamed the volatility on issues with its algorithms used in its high-frequency trading platform.
If the stock market can move downside on software glitches, such glitches can also move the stock market higher which goes unnoticed.
Follow the following strategies to protect your portfolio from HFT:
1. If you want to buy stock, use limit order.
2. Plan for long term atleast (1-3 month) and ignore the current news and limit your risk.
3. Don't invest more then $2000 at time Or else your account will turn negative in no time.
4. Ignore the current news.
5. Follow the weekly CFTC report which show big institution Long and Short position. (If you read the report carefully, Big institutional investor bet opposite of retail investor).
Other way to tackle HFT:
1. Stop trading.
2. Buy real asset like Gold, Silver or Real estate which has real value.
Real problem for HFT:
1. It has no human control except shut down.
2. If any HFT machine stops working, it will create sell off.
3. Increase in fear volatility (VIX) only increases the chances of "Flash Crash" or or "Major Stock market crash" by HFT like May 2010. This is one of the reason, VIX is selling off and now at 52 week in a low volume HFT market.
