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High Frequency Trading Essay

1669 words - 7 pages

Introduction:
It is obvious that during the last two decades the financial market has changed. The main cause of development is the result of human knowledge of information technology (IT). The story behind the new structured market can be defined as new ideas and opportunities to make more money being help by computers. Indeed, a clear advantage of computer-aid trading is having access to higher speed. Nowadays, in market place, not only minutes have lost their values but also seconds are becoming worthless. The time aspect of today’s highly electronic age is measured in milli, micro, or even nano-seconds. High Frequency Trading, commonly known as HFT is one of the popular ways of trading using computers. Indeed, HFT is computer determined trading; the algorithm, beforehand programmed by human, makes important decisions such as timing, price, or in many cases, executing the entire order without human interaction . In this survey, we will focus on HFT, its history, its advantages together with its drawbacks and its future. Our main concern will be to try to answer the following question:
Is this market takeover by computers the future of trading or the first steps to a collapse of market?


History of HFT:
The history of HFT began in 1989, when Steve Swanson, a young programmer, and Jim Hawkes, Swanson’s college statistics teacher, decided to program algorithms from predictive formulas for the stock market in order to predict stock prices, to automatically trade and to finally make money. This would later become the world’s first HFT firm, Automated Trading Desk (ATD). At this period, the only way of trading was still manually posted offers of trade on handwritten tickets. It was then an easy prey for ATD trades execution within one second; that was therefore faster than anyone else.
A major turn point for HFT appeared in 1998, when the U.S. Securities and Exchange Commission (SEC) authorized electronic exchange. This was an open door for computer based trades services able to execute trades more than 1000 times faster than a human. Other big HFT entered the market, such as Getco, Knight Capital Group, or Citadel. The race for transactions speed and market volume was on.
In more than 10 years, technology has improved trading execution time from several seconds, to milliseconds. It has also resulted in a large increase of market volume by HFT equity trades in the US; from 10% in 2000, to 35% in 2005 and even 56% in 2010. Till this period, HFT was relatively unknown by people outside the financial sector. One of the first articles to raise public’s attention was written by the New-York Times in July 2009. But with so many HFT firms on the market, it became hard to make profit enough to cover the technology expenses.

Added to that, an unfortunate event happened on May 6th 2010, the Flash Crash. An HFT transaction of $4.1 billion triggered a plunge from the Dow-Jones Index of 1000 points (almost 10% of the total index) during a few minutes...

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