High Frequency Trading: Man vs. Machine

High frequency trading has existed for several years, but recently the trading strategy has come under a lot of added scrutiny. Traders utilize computer algorithms and lightning fast data connections to receive data and place trades at intervals quicker than the average trader. When you and I place trades online, a confirmation is generated in under a second. A second is way too slow for these guys.

There’s nothing illegal about somebody devising a system to buy and sell stocks at a faster rate, but many people see something wrong with HFT. A lot of these people blame HFT for causing some major market “glitches”. Which “glitches” am I referring to? I’ll list a few:

  • Flash crash – May 6, 2010 “at 2:42 pm, with the Dow Jones down more than 300 points for the day, the equity market began to fall rapidly, dropping an additional 600 points in 5 minutes for an almost 1000 point loss on the day by 2:47 pm. Twenty minutes later, by 3:07 pm, the market had regained most of the 600 point drop.”
  • Facebook IPO debacle – “The debut was delayed for 30 minutes because of technical difficulties. That was followed, according to a source familiar with the matter, with an “overwhelming influx of orders” to buy, sell and cancel trades causing Nasdaq’s trading software to go haywire.”
  • Knight Capital system errors – This is an example of HFT gone wrong. Knight Capital had installed a software upgrade overnight and on the next day, months worth of trades were executed in 15 minutes and left the firm considering bankruptcy. “The algorithmic error caused erratic trading activity and left the firm with billions of dollars in unwanted securities.”

Even if you feel that HFT trading is perfectly acceptable and a natural progression of our society and the use of computers, you have to realize that as a “regular guy”, there’s no way that you could ever beat HFT. These algorithms analyze data and react and a speed that can never be matched by a human. As a trader myself, I witness HFT every day, but it wasn’t until I viewed this infographic that I actually realized just how fast it is:

high frequency trading infographic

READERS: How do you feel about HFT trading? Do you think it should regulated more or banned all together? Has HFT affected you in any manner? Facebook? Flash crash? 

 

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About JW

Trader for 14 years. Series 7 & 63 licensed. Masters in Financial Management. Teacher of 100+ hours of financial education classes.

Comments

  1. JW, another great article and infographic! I’m not a trader so my opinion is only based on my gut. With that said, I think HFT should be more regualted. With the amount of trades they can execute it really changes the flow of the stock market.

    Haven’t some stocks crashed way too fast because of high selling? And this was humans selling. What impact does HFT have on that? Wouldn’t it crash faster?

  2. Some stocks have definitely been affected by HFT. On the day of the Facebook IPO, there were major NASDAQ system issues during the first 15 minutes of trading. This happened because millions of orders were modified/cancelled just seconds before the stock opened for the day.

    This has nothing to do with where Facebook is trading today, but the stock was negatively affected on day one. A lot of people speculate that it never received that initial hype induced bounce, because nobody could get confirmation of their buys/sells.

    • I wonder how high it would’ve gotten if it had that initial hype. You don’t think that affected the current price? Like if it had gone higher maybe it wouldn’t be as low as it is today.

      • I think the price was definitely affected by the Nasdaq issues. Nasdaq allows for cancellations and modification of orders up until the time that the stock is to begin trading.

        Every time the opening price of FB was adjusted, millions of orders were modified. Of course, when this happened millions more orders were altered. All of these modifications/cancels caused the system to bottleneck. This resulted in the delayed reporting of many buys and if you didn’t know you bought the shares, you could not sell them. Some people didn’t find out they had purchased FB until days later.

        I think the stock still would have dropped because of Facebook’s poor mobile revenue numbers. As you said though John, it may not have dropped into the teens had it started higher.

  3. I think the system is working correctly: Facebook and NASDAQ are suffering lawsuits, while Knight Capital is getting the downside of not completely testing systems before activating them. I think HFT is higher risk/higher reward, right? Higher reward also can mean higher losses.

    • For the most part, I agree that it’s working Joe. Recently though, the NYSE has been found guilty of allowing access to HFT before others. This is not acceptable as it creates an uneven marketplace.

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