Chapter 13 - High Frequency Trading (Done) Flashcards
What is High Frequency Trading (HFT)?
High Frequency Trading (HFT) is a type of financial trading that uses powerful computers to transact a large number of orders at extremely high speeds. These high speeds are measured in fractions of a second, known as microseconds and milliseconds.
What are the characteristics of high frequency trading?
- Highly Automated: HFT relies on algorithms that automatically execute orders based on certain market conditions.
- Very High Trading Volume: HFT strategies often involve a large number of orders at very high speeds which contributes to high daily trading volumes.
- Short Holding Periods: Positions are typically held for very short durations, sometimes just seconds or milliseconds.
- Low Number of Overnight Positions: Most HFT firms close their positions before the market closes to avoid holding risk overnight.
- Low Capital Investment: Relative to the profits that can be made, the capital investment is typically low.
What is the relationship of HFT to other forms of trading?
HFT is distinct from traditional trading methods due to its speed, volume, and use of sophisticated technology. It interacts with and sometimes competes against other forms of algorithmic trading.
What are the origins of the HFT market?
HFT evolved from simpler automated systems due to advancements in technology and changes in market structure, such as:
- Legislation: Regulatory changes have increased competition among stock exchanges.
- Decimalization: Switching from fractional stock prices to decimals which tightened bid-ask spreads.
- Technology Improvements: Enhancements in computing power and connectivity.
Describe the size and composition of the HFT market.
The HFT market includes a variety of participants like proprietary trading firms and certain hedge funds. The exact number of active HFT firms is not well-documented due to the secretive nature of the strategies used.
What is the application of HFT to non-equity markets?
HFT strategies are also applied in other financial markets including:
- Futures
- U.S. Equity Options
- Foreign Exchange
- ETFs and Index Futures
What is the theoretical basis and practical implementation of HFT?
HFT is based on the efficient market hypothesis to a degree, leveraging advanced mathematical models to make profitable trades. Setting up a new HFT strategy involves careful planning, testing, and deployment of resources.
What are the primary strategies in HFT?
- Market Making
- Rebate Trading
- Filter Trading
- Momentum Trading
- Statistical Arbitrage
- Technical Trading
What do industry trends and the regulatory environment look like for HFT?
The HFT industry is constantly evolving, characterized by tighter regulation following events like the 2010 Flash Crash. Trends include lower latency connections and the expansion into new markets.
What are some key terms associated with HFT?
- Algorithmic Trading: The use of algorithms to make trade decisions.
- Co-Location: Hosting trading servers physically close to exchange servers to minimize latency.
- Direct Market Access (DMA): Financial market access that allows firms to place trading orders directly into the market’s trading system.
- Drop Copy: A method of transmitting a copy of each trading order or trade confirmation from one system to another.
- High Frequency Trading (HFT): Trading platforms that execute orders at extremely high speeds using algorithms.
- Latency: The delay before a transfer of data begins following an instruction for its transfer.
- Liquidity Rebates: Incentives provided by exchanges to encourage market makers to increase market liquidity.
- Proprietary Latency: The unique processing delay inherent in an organization’s trading infrastructure.
- Round-trip Latency: The total time it takes for a signal to go to a destination and back.
- Sponsored Access: When a firm accesses a trading venue through another firm’s trading infrastructure.
