By Sam Chee Kong, 20/08/2011
Markets are purely about Speculations. There is no more such thing as
INVESTING in the markets. It is just Speculation on different
we have the market that is made up of retail and institutional
investors together with the market makers that facilitates these
investors. In the last couple of years, there have been much changes in
the investment landscape and that is High Frequency Trading or HFT for
short. HFT accounted for about 70% of daily trading volume in NYSE, 60%
in Europe and 50% in Asia. In other words there is a paradigm shift in
the traditional Investors Buy and Hold market to a Trader’s market.
or High Frequency Trading refers to large and very fast execution of
quote orders by computers programs which will create cascade like buying
cycles what seems to be days and weeks now are being done in
milliseconds and nanoseconds. In other words market has shifted from the
traditional (fundamental and technical analysis) with long term holding
for equity appreciation to short term trading that benefit only the
speculators. The strategy of investing today refers to ‘here and now’
rather than ‘buy and hold’.
we know HFT is the main culprit during the infamous May 6, 2010 “Flash
Crash”, where the Dow plunge more than 700 points in just a few minutes
only to recover a few minutes later. The whole process was initiated by
the sale of $4.1 billion of security by US money manager Waddell &
Reed Financial Inc and was accelerated by other HFT traders.
multiple orders coming from multiple locations and multiple HFTs had
resulted in what they called the “QUOTE STUFFING”. The number of quotes
coming in simultaneously from the HFTs just overwhelms the computers at
the exchange and basically jammed it. That is why during that time
there are a lot of stocks that are trading with the absence of buyers or
buyers bidding at very low prices and this is one of the main
contributor to the Flash Crash of 2010.
new trendy word in HFT trading is ‘SHAVING’. It refers to the use of
ultra high speed computers to engage in high speed computing so as to
shave off the time in buying and selling of stocks, often within
to give you a glimpse of what technology are available in the financial
markets nowadays. People like Nanex who developed the NxCore which is a
streaming WHOLE MARKET data feed (ticker plant) and comes with an API
(Application Programming Interface) for developing your own trading
software. It essentially brings the whole market, like the hyperactive
US Options Market (OPRA) which transmits over 1.7 million quotes per
second to your desktop. NxCore only requires a low end Pentium 1.0 Ghz
with 80Mb hard drive to receive and database 1.4 million quotes per
second or over 6 billion quotes per day and with a CPU usage of less
than 5%. It can accomplish this task is because of its award winning
proprietary data compression technology. It is basically like
Co-Locating your PC next to the Data Farm Servers in NYSE.
is known to have leased space INSIDE their data warehouse for HFT
platforms. This is also call Co-Locate. The closer you are to the data
center, the more picoseconds you will likely shave off. In other word
the big boys are practically trading directly from the exchange lock-ups
!! And of course these exchanges are making a killing out of renting
these spaces. Forget about the exchange imposing rules to deter HFT
because they themselves are in it as well.
is also on the way to promoting full scale HFT, as a senior official
from one of India’s Stock Exchange said that ‘its bourse is allowing
large brokerages/fund managers to place their terminals inside the
bourse so as to speed up their orders’.
few years ago, trading firms are talking about milliseconds. 1
millisecond is 1000 of a second, however milliseconds is already
history. In the past 2 years trading speed had been shaved down from
milliseconds to microseconds and now nanoseconds. Recently they are
talking about reducing the speed of execution down to picoseconds. A
picoseconds is one trillion of a second or put it rather naively it is
like one second in 31,700 years.
to Donal Byrne, CEO of Corvil, a high speed trading technology company
specialize in providing low latency network management, suggested that
in a not too distant future trading speed will be reduced to
good example of a Flash Crash generated by HFT can be seen in the stock
chart of Brown Forman. It took only one second to bring down the price
of Brown Forman from $70 to $16.64, a 75% or $7.5 billion loss for a
$10 billion dollar company. The chart below shows the price, size and
time action of the stock.
reason for the competition to ‘race to zero’, is because it enable them
to ‘front run’ their competitors. By front running it means it
effectively put them at the front of the queue and have priority over
other orders and help them react faster than others. According to some
people in the know, Citadel which is one of the HFT heavyweights
receives order flow from brokers like TOS. When they receive orders,
they can decide whether or not to fill your order according to your
price. If they fill you up then they will know exactly what are the
small players buying, their market sentiment and momentum. By totaling
the retail orders they are able to judge market sentiment on a
particular price and also the pain threshold of the weak holders.
HFT programs are design to block retail investors from making
successful trades against the house or Wall Street. An example in the
following shows how the game of front running being played. Say stock
ABC is being traded at the bid of $1.00 and ask $ 1.02. As a retail
investor key in an order to buy at $1.02, normally it will get filled.
But HFT programs which is ‘able to see’, will automatically raise the
ask price to $ 1.03. So the next bid price will be higher and
automatically set as $1.01, so that the HFT programs make the human
investor to buy higher at $ 1.03 instead of $ 1.02.
to Themis Trading Analysis white paper the profits generated by HFT and
Algorithmic (algos) trading can go as high as $ 3 billion a year even
though margins generated from each trade ranges from $0.01 - $ 0.02.
Although they are not making much money from such spreads but they are
making a killing from liquidity or Volume rebates of 0.005/share from
the exchange. It is reported that Goldman Sach’s HFT trading alone
revved up something like 2 billion shares a week and you times that with
$0.005/share and times again 52 for the rest of the year and the figure
surely adds up!!
short, HFT trading is just basically latency arbitrage and those with
ultra high speed computer hardware will always stays on top. And with
its predatory HFT programs which is design to trigger cascade like
buying and selling and also front running the chances of them losing in
the market is minimal
have already made its presence in Asian markets. If you pick any top
five counters in any Asian bourse especially the Indonesian JSX. Just go
to the ticker tracking and you will be able to see some action of HFT.
As an example, say counter ELTY trading at 156 rupiah, when you click
the stock tracking you will be able to see many transactions done at 156
with similar lots size say 20 lots per transaction. Sometimes there
will be 200-500 transactions of 20 lots at 156 rupiah done within 2-3
seconds. This is the footprint of HFT because there is no way any human
can key in so many transactions within 2-3 seconds.
essence financial markets are rigged like the casinos. In the game of
Black Jack, if the casino loses money on a particular table it will
first attempt to change the deck of cards. If the table continues to
lose then they will change the croupier and if it still loses then
eventually they will close the table. They will always change the rules
as in financial markets.
main reason the exchanges are not banning HFT is because it is
providing liquidity to the market, tighten the spreads and hence lowers
financial markets, if you win consistently the big boys will deploy
predatory HFT programs that will allow them to step in front of a trade
which they are able to ‘see’ and front run the retail investors and thus
reducing their profits. At the end of the day the markets are design to
benefit the FEW and not the majority average Joes. In order to make
money and survive, you need to understand the rules of the game and also
learn how to exploit the weakness of the big boys.
the moment the traditional method of investing using due diligence in
fundamental data and technical analysis may still work for the retail
investors. But they have to expose themselves to frequent bouts of
40-60% decline in markets.