High-Frequency Trading

Understanding High-Frequency Trading: A Closer Look at Millisecond Markets

High-frequency trading (HFT) has sparked significant debate in financial circles, especially in the US and UK, where some regulators and market participants have labeled it as potentially unethical. This modern form of trading leverages speed and technology to gain an advantage, sometimes executing trades in milliseconds, well before the broader market has time to react.

Here’s an insightful overview of HFT and its implications.

What Is High-Frequency Trading (HFT)?

High-frequency trading is a type of algorithmic trading that uses advanced computer systems and ultra-fast internet connections to open and close trading positions in mere milliseconds. This is why it's often referred to as trading in the "millisecond markets."

HFT systems are designed to detect small market inefficiencies or price discrepancies and execute a vast number of trades in a very short time—sometimes thousands per second.

Concerns Raised by Regulators

New York Attorney General Eric Schneiderman has expressed concerns over the advantages high-frequency traders (HFTs) may gain due to preferential access to:

• Real-time market data (e.g., volume, pricing, and order confirmations)

• Co-location services offered by stock exchanges

“If a firm can detect a large order from an institutional investor, like a pension fund, it can instantaneously position itself on the other side of the trade, driving up the prices artificially,” Schneiderman stated.

Such behavior can lead to an unfair trading environment, benefiting a few at the expense of long-term investors.

Systemic Risks of Automated Trading

According to the BBC, automated trading systems have been involved in several major market disruptions:

• Knight Capital (2012): A software glitch caused the firm to place 150 erroneous trades on the NYSE, resulting in a $440 million loss within minutes.

• Flash Crash (May 2010): Markets plunged 5% within minutes and then quickly rebounded. Stocks like Accenture dropped to almost zero, while others like Apple surged to $100,000. The exact cause remained unclear for months.

These events demonstrate that while HFT can increase market liquidity, it also amplifies systemic risks and market instability.

Regulatory Crackdowns: Spoofing and Layering

High-frequency trading has also attracted legal scrutiny.

In a high-profile case, Michael Coscia and his firm, Panther Energy Trading, were fined more than $3 million by regulators in the US and UK for illegal HFT practices:

• FCA (UK) fine: $900,000

• US regulators’ fine: $2.1 million

Between September and October 2011, Coscia used algorithmic programs to place large false orders in oil and gas markets—only to cancel them immediately after affecting market prices, a practice known as “spoofing” or “layering.” He made around $1.4 million through this manipulation.

Scalping the Market: Speed as an Edge

High-frequency firms often engage in scalping, targeting tiny profits on each trade, but multiplied over massive volumes. Success in this domain depends on:

• Closer server locations (co-location with exchanges)

• Straighter and faster data cables

• Ultra-low latency trading algorithms

Even a millisecond advantage can determine profitability.

The "Race to Zero"

The global HFT industry is engaged in a relentless “race to zero” latency, investing billions in reducing trade execution times. Here’s a comparison of major advancements:

(Source: Wired Magazine)

At exchanges worldwide, traders pay premium fees to physically position their servers closer to the exchange's data centers—a practice called co-location. This minimizes delay and boosts trading speed.

Conclusion

High-frequency trading represents the cutting edge of modern finance—but it also raises significant ethical and systemic concerns. While it can enhance liquidity and efficiency, it can also exacerbate volatility and create unfair advantages. Regulatory bodies in both the US and UK continue to monitor and fine-tune oversight to address the risks associated with this powerful trading approach.

■ Based on reporting from the BBC UK (BBC UK)

Fxpros.net (c)