High-frequency trading, also known in the financial field by its name in English high-frequency trading (HFT), is a type of trading where a large number of stock purchase and sale orders are placed on the market , with a speed of hundreds or thousands of orders in fractions of a second.
With this shipment of orders, high-frequency machines flood the order market (this does not mean that they are all executed), since in many cases they do not have a counterpart to buy or sell it. The market works like this, there must be someone on the other side of the price table who is willing to buy or sell.
High frequency trading and market manipulation
To this excessive proportion of orders in the market there are many authors who consider them market manipulation, due to the creation of micro trends . Others, on the other hand, consider it a crime to seek low latencies, something fundamental for the development of their activity. HFTs need the response time between their computers and those in the market to be as low as possible. Therein lies its comparative advantage.
The HFT is carried out in the financial markets intensively using sophisticated technological tools to obtain market information and, based on it, launch the orders to the market, being carried out with a multitude of financial assets such as stocks or even financial options .
There are numerous theories for and against HFT, many of them criticize the speed with which these operations are carried out and the short time they are kept in the portfolio, while the others defend these systematic trading systems for the liquidity they offer to the market by always maintaining counterparties on both sides of the price table.
The volume traded in the markets by these “operators” reaches very high levels. Especially in the daily market volumes of liquid markets.
Where are the high frequency machines located?
Its sophisticated computers are physically located very close to the computer systems of the exchanges and other trading platforms. This allows them, in fact, to see the orders of real investors before anyone else and to anticipate. This breaks the principle of equal access to markets, and many claim that HFT systematically perform front running (an illegal practice where the operator takes advantageous positions due to the fact that they can be seen before on behalf of third parties), something prohibited by regulation.
The arbitrage between markets or financial assets has gone for traders . You cannot compete against a machine that sends orders a million times faster. Although this is positively valued because they align the market at the speed of light, but on the other hand, they make many intermediaries and jobs disappear (little by little the machines are replacing the human machine).
Before naming the risks and possible solutions, it should be noted that there are detractors as defenders.
What are the risks of high frequency trading?
These are some of the risks involved in doing this practice:
- Operational risks:Failures of the networks of the markets that are highly interconnected.
- Risks for the integrity of the market:Due to abuse, manipulation and front running.
- Risks to financial stability:It negatively affects the confidence of real investors.
What solutions are there?
Possible solutions to these risks include:
- Review its regulation.
- Higher capital requirements for HFTs.
- Limit the ratio orders and operations.
- Limit the time a title must be kept in the market.
Below is a video of the flash crash corresponding to May 6, 2010 the Dow Jones Industrial Average Index plummeted close to 1000 points, approximately 9%, to recover that loss just a few minutes, and where some traders won and lost huge amounts of money.