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Perfect Competition – Economics of Competitive Markets
Perfect Competition – Economics of Competitive Markets

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High-frequency trading

High-frequency trading (HFT) is a type of algorithmic trading characterized by high speeds, high turnover rates, and high order-to-trade ratios that leverages high-frequency financial data[1] and electronic trading tools. While there is no single definition of HFT, among its key attributes are highly sophisticated algorithms, specialized order types, co-location, very short-term investment horizons, and high cancellation rates of orders. HFT can be viewed as a primary form of algorithmic trading in finance. Specifically, it is the use of sophisticated technological tools and computer algorithms to rapidly trade securities. HFT uses proprietary trading strategies carried out by computers to move in and out of positions in seconds or fractions of a second. It is estimated that as of 2009, HFT accounted for 60-73% of all US equity trading volume, with that number falling to approximately 50% in 2012.High-frequency traders move in and out of short-term positions at high volumes and high speeds aiming to capture sometimes a fraction of a cent in profit on every trade. HFT firms do not consume significant amounts of capital, accumulate positions or hold their portfolios overnight. As a result, HFT has a potential Sharpe ratio (a measure of reward to risk) tens of times higher than traditional buy-and-hold strategies. High-frequency traders typically compete against other HFTs, rather than long-term investors. HFT firms make up the low margins with incredibly high volumes of trades, frequently numbering in the millions.It has been argued that a core incentive in much of the technological development behind high-frequency trading is essentially front running, in which the varying delays in the propagation of orders is taken advantage of by those who have earlier access to information.A substantial body of research argues that HFT and electronic trading pose new types of challenges to the financial system. Algorithmic and high-frequency traders were both found to have contributed to volatility in the Flash Crash of May 6, 2010, when high-frequency liquidity providers rapidly withdrew from the market. Several European countries have proposed curtailing or banning HFT due to concerns about volatility. Other complaints against HFT include the argument that some HFT firms scrape profits from investors when index funds rebalance their portfolios.
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