Will high frequency trading disappear?

Original author: Preslav Raykov
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Economist Preslav Raikov posted on the Market The Mogul blog about the prospects for high-frequency trading. We selected the most interesting thoughts of the expert.

High frequency trading (HFT) has existed for a long time and in recent years has faced a number of problems: physical boundaries, rising infrastructure costs, competition, reduced profits and increased regulation. Because of all this, the share of HFT in total trade is steadily declining in the western market. However, high-frequency trading still accounts for more than half of all transactions in the US and Europe.

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But after almost 10 years of rapid technological development, dozens of cases of market collapse and increased trading speed, high-frequency trading can be seen as a natural outcome of attempts to make financial markets more efficient, bring them closer to theoretical purity and enable them to immediately reflect any new information.

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HFT is a game with an infinite number of conditions that can be added to an existing set of steps. When the algorithms are developed and the initial parameters are set, the technology of high-frequency trading seems surprising, because it contains human judgments and reactions, emotions, fears and hopes in the framework of microsecond transactions.

In relation to the HFT, the financial world is divided into two camps: those who think that the stock market has benefited from this technology, and those who claim that high-frequency trading is beneficial only to a handful of academics supported by venture funds, and trading platforms that have gained advantages over retail by investors.

The influence of high-frequency trading was wide and probably lasting. HFT infrastructure and practice may become indispensable attributes for the financial industry of the future, as high-frequency trading improves the quality of markets not only for institutional investors, but also for retail.

High frequency trading and market quality


It is believed that like everything very complex, dynamic and difficult to learn, HFT has a double effect on the stock market. High-frequency trading algorithms are speed-oriented, mainly because most of them use arbitrage or passive investment strategies to generate their income.

Higher trading volumes and liquidity are the most significant, long-term and noticeable effects on equity markets today. Total US stock trading has doubled since the advent of high-frequency trading.

The ultra-high trading volume leaves no options for players looking for tiny profits from millions of transactions, so the growth in volumes has significantly changed the balance of power in the market. This means that HFT algorithms increase liquidity due to passive marketing.

This feature of high-speed traders plays an important role when there is a significant outflow of liquidity from ordinary suppliers during market shocks caused by important macroeconomic news, political events or natural disasters.

Effect of volatility


Profit for most HFT players requires extremely high levels of volatility of preferred assets. On the other hand, stock price volatility is the main building block of the market. Therefore, high volatility is undesirable for large institutional investors and companies. It can lead to an increase in the perceived risk of the company's shares, and, consequently, to an increase in the weighted average cost of capital - the costs of providing each source of financing for the company.

Ultra-high trading volumes resulting from high-frequency trading affect the dynamics of price changes during the trading day and can reduce stock volatility, as HFT players provide liquidity to the market and allow large traders to complete their transactions without significantly affecting stock prices, indirectly reducing price deviations .

The argument that this liquidity is a kind of fake can be refuted by the fact that strategies in the high-frequency trading market do not benefit from the movement of stock prices. They create income from the difference in purchase / sale prices and discounts provided by the electronic system of transactions of sale and purchase (ECN).

Spreads and transaction costs


High-frequency traders disclose the largest and most liquid assets, constantly provide liquidity and actually form a market, so we can say that HFT reduces the difference in buy / sell prices for companies with large capitalization and contributes to faster pricing in the market.

The effect of increased liquidity may allow traditional institutional investors to more easily adjust their portfolios to reflect their fundamental views on company performance. In this way, HFT can reduce the transaction costs that institutional investors face and helps bring market prices closer to their fundamental value.

Not everyone likes high-frequency trading, but it clears the market of irrational investors. Because of the HFT, they are unable to withstand lightning-fast price changes.

Conclusion


Since the 2000s, significant changes have occurred in the financial markets, especially in the area of ​​algorithmic and HFT transactions. Since this environment has changed by the beginning of 2010 and enough time has passed, we can assess the impact of high-frequency trading on the market.

There will always be two points of view at the HFT, but it must be taken into account that in 5-7 years, high-frequency trading will be closely linked to artificial intelligence and machine learning. Recent improvements in high-frequency trading have significantly changed the course of trading processes in the markets, but it is unclear whether this effect will be positive or negative.

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