Wall Street Wolves: A High Frequency Trading Story From Thomson Reuters Expert

One of the heroes of the book by Michael Lewis Flash Boys (adaptation translation is published on our blog: one , two , three , four ) Brennan Carley, head of the department of analytical platforms and solutions at Thomson Reuters, in an interview for ITinvest Youtube channel answered popular questions regarding high-frequency trading, raised by Michael Lews in his best-selling book. Transcript of the conversation in our material today.

Why high frequency trading is widespread in the USA

The development of high-frequency trading was due to the course of the history of market development. Firstly, over time, trading on many exchanges themselves has switched to electronic mode. The second important point is that for a long time the American stock market worked in a system of simple fractions, but subsequently a peculiar revolution took place on it.

Previously, the unit for measuring the price of a stock (or derivative financial instrument ) was $ 1/16 (about six cents). The main players in the market at that time were large brokerage companies, market makers. They could handle the huge volume of orders for the purchase and sale of shares, which allowed them not to seek to make big profits on each transaction - the optimal profit was $ 1/8 per share.



Brennan curley

After the introduction of decimalization in 2001, stocks on the New York Stock Exchange NYSE began to trade using the decimal system - the minimum change in price began to equal 1 cent, and not 1/16 dollar. A smaller price change step means greater liquidity of the stock in decimal quotation, which reduces risks and expands the number of available trading strategies and ultimately makes stocks more attractive.

Here is how the consequences of this step are described in Wired magazine’s article “Raging Bulls: How Wall Street Got Dependent on“ High-Speed ​​”Trading” (we translated it here: one , two , three , four , five ):

Some algorithms are “market makers” of the exchange - they try to buy shares at the lowest purchase price and quickly sell them at a slightly higher selling price, collecting the difference called the spread. People who did this were called specialists before, and made good money when spreads reached the eighth of the dollar. Since the “decimalization” was announced on the New York Stock Exchange in 2001, the spread has been reduced to a penny or two, which means that in order to earn the same money, you now need to process a lot more transactions and do it several times faster. This sphere of trading on the exchange has ceased to be the lot of people.

Is it true that HF ​​trading is harmful to the economy and “distorts” the real prices of financial instruments

Sustainably developing markets are characterized by fragmentation (the presence of several exchange platforms, which allows for the implementation of arbitrage strategies) and fractality - next to larger participants, there are always smaller ones that work with less financial resources and at shorter time frames, while making more transactions ( so that in the end their turnover may exceed the turnover of large investors).

Under normal market conditions, HF traders are at the very end of this chain, but this is not always the case (for example, in Russia at the moment there are more such traders than long-term investors, which somewhat upset the market balance ).

Michael Lews book describes the situationwhen a trader Brad Katsuyama sends an order to buy 100,000 AMD shares, and thereby “moves” the market, for a short moment creating a mismatch between supply and demand of shares. The market function is to find an equilibrium price between supply and demand. HF merchants cannot change this market function and only adjust to supply and demand.

Does the volume of high-frequency trade depend on the development of the economy of a particular country?

For some high-frequency trading strategies, situations are well suited, such as the one that has developed in the Russian economy now - crisis phenomena, panic in the markets create volatility, everything changes very quickly. On such movements, prices can make good money using arbitrage strategies. Therefore, in Russia there are some prospects for the development of this kind of trade.

It is important to understand that in Russia there is one large exchange, and arbitrage strategies are most often created to work with shares traded on the Moscow Exchange and, for example, on the London Exchange. In the US, traders can create arbitrage strategies within the country, since there are a large number of exchange platforms.

In addition, for one trader to earn money in the market, another must lose money, and here the overall amount of finances in the market comes to the fore. HF-traders can only work against other market players (medium and long-term investors). If there are fewer such investors, and the market itself is shrinking, this reflects poorly on the income of HF traders.

How HFT Merchants Make Their Strategies More Effective

One of the most popular areas of HF and algorithmic trading of recent times is a machine analysis of news and their tonality (including in social media) - such information can be used by arbitrage robots for more efficient work.



If the system notices a spate of discussion of the company whose shares are included in the strategy, for example, on Twitter, then it can analyze the tonality of these references and make adjustments to the strategy (adjust the dependencies between the basket of securities used in the arbitration model) in real time ( orders to buy or sell such a share will not necessarily be generated; rather, it is better to temporarily stop trading).

Who is more successful in the market: “ordinary” investors or HF-traders

When an investor decides to buy or sell a particular stock, he makes a definite bet on it. The result of such a decision can be either profit or loss. Large investors risk large sums of money.

At the same time, HF-traders make very, very small bets, but their number is simply huge (tens of thousands per day), which allows them to flexibly change their behavior in the market. Therefore, if 70% of such small bets play a plus, and 30% lead to losses, then the HF merchant will remain in the black. The size of the profit will not be so large due to the small size of the same “rate”, but in the long run, HF-trading is more profitable than usual investment activity.

A video interview is available on YouTube:



Thanks for attention!