Technology powers high frequency trading

Technology evolution speeds high frequency trading to markets

From carrier pigeons to nanosecond trading, communication progress continues. Communications now operate faster than any eye can see or the human brain can process. HFT uses near light speed messaging to gain huge time edges over human investors.

That is HFT using technology power. Communication, processing and programming advances put cutting edge computer science in stock markets. The technology, time and information edge makes HFT dominant in stock markets. In fact applying technology pushes HFT ahead of any human trader or investor.

Investors grasping the power of HFT understand that. Once knowing, we can set about learning how to deal with this HFT risk. Knowing what to do money working for investors and away from HFT. This course teaches what you need to know to limit the impact of HFT on your portfolio.

Stock market evolution from sailing ships to high frequency trading

From financing the first sailing ventures until today, stock markets continually evolve. Those changes are parts of the never ending race for wealth. Greed and the need for speed rather than fairness and stability drive markets. Four centuries of the ever faster speeds brings us to our era that includes technology powered high frequency trading.

Evolution continues for stock markets and high frequency trading

Financial services, regulators and markets do a poor job of informing investors. Especially about HFT. After all, it is an inside scheme for many of them. They or associated companies are insiders of the HFT scheme. That conflict puts their interest ahead of the best interests of investors. They all profit so there are no complaints from that inside gang.

Trading anything anywhere now can expect to encounter HFT. That includes equities or stocks, bonds, options, commodities and currency including cryptocurrency. Current HFT iterations have huge and growing impacts on markets, investing and economies. The torrid growth rate continues.

SEC projects an incredible 29% trading growth from 2019 to 2020! That projection is for all trades but such an increase be will virtually all HFT. Although complex, HFT will continue getting more so with each iteration. That certainly demonstrates the results from how HFT uses technology power to profit.

3 core evolutions work together advancing the technology powers of high frequency trading

To recap what Lesson 3 illustrated, 3 interacting technologies form the core of HFT power. HFT uses technology power of:

1. Communication Technology
​    - evolving from sailing ships to light speed messages. 

2. Calculating Technology 
    - evolving tote boards to nanosecond computer processors. 

3. Coding Technology 
    - evolving from counting on fingers to AI. 

These interrelated advanced technologies enabled the development and use of very sophisticated algorithms. Those algorithms made possible very effective automatic communication and trading systems. HFT firms apply and exploit every technology advance. Automated traders only battle one another. Human investors and traders remain far behind. HFT exploit those advantages to produce massive profits!

From carrier pigeons to high frequency trading

Long ago Rothschild traded on carrier pigeon news for an advantage in London. Knowing of Napoleon’s defeat first let him trade to add to his fortune. As always, through the history of markets, being the first to know gives a profit making advantage.

As always, speed is money. It becomes clear being first to know news or about events gives investors an advantage. First and better informed investors move to the front of the line to profit by buying or selling first.

Telegraphs had the edge in the 19th century. Then in 1983 Bloomberg introduced the first computerized real-time price feed. Soon the Bloomberg Terminal became standard equipment to play on Wall Street. Every serious stock broker’s office across North America and beyond had one. In that same year, NASDAQ introduced terminal to terminal electronic trading technology.

Electronic trading mutations produce high frequency trading

In 1987, an old fashioned stock market crash happened. One e ffect was spurring developers to march on to the universe of electronic trading. Although it was 2008 before the SEC approved electronic trading, it happened well before than. Numerous mutations and derivatives of electronic trading sought and applied ever more advanced technology. 

In that environment and under that umbrella, HFT grew. The electronic trading umbrella also covers many useful and legitimate electronic trading systems. However, predatory mutations also developed to prey on real investors. From the largest to smallest real investors fall prey such predatory trading.

Blinking misses 30,000 trades!

A blink misses 30,000 trades and a few other tech facts helps us grasp how HFT uses technology power including blazing speed to rig markets. Understanding that helps us understand this essential advantage of HFT systems.

A human blink happens in 0.3 seconds or 300 milliseconds. In that time more than 30,000 HFT transactions can happen! Now messaging technology operates at speeds faster than milliseconds! The best messaging systems move data at nanosecond speeds.

Such signals move a meter in 5 billionths of a second (5ns) or rounded, a foot every 1 billionth of a second! Imagine traveling 2+ times around the world during our 300 milliseconds eye blink!

When trading, moving a message a billion feet in 1 second matters! Nanoseconds and milliseconds are a big deal in both data processing and communications. Technologies taking advantage of those speeds are essential parts of HFT power. Combining communication, computer and programming speed gives HFT an edge over all humans.

Fast becomes faster trading

Early in the 21st century HFT execution times reached microseconds. As the lesson 3 infograph shows, HFT uses technology power reaching nanosecond trading speeds in 2011!

Speed weapons, like all HFT advances, deployed with no investor notice or education. That disadvantaged all investors. It included the small and those running the largest funds in the world. None were aware or understood these HFT developments.

HFT developed, grew and became a market force in secret! That secrecy is the most amazing part of the HFT story! HFT developed and deployed in markets as an insiders play!

When HFT began, few market insiders were in the know. Anyone that stumbled upon or learned the secret rushed to join the greed grab! Obscene profits motivated them to keep quiet. They did not want to risk ending their profitable game by telling investors. They did so for years.

Another amazing fact. Although secret, the HFT schemes unfolded in plain sight. HFT successfully hijacked market forces at the intersection of several associated technology developments.

Real investors including the most informed and sophisticated large fund managers. They were the prime targets and did not know it. For years the schemes remained unknown to all real investors.

Computerized trading authorized

Looking back, we can now see a 1998 Securities and Exchange Commission (SEC) decision as a milestone. They then authorized computerized trading. That immediately spurred development and trading changes that opened market doors to computers. In time that became HFT.

Although SEC permitted computer trading, not everyone was onside. The NYSE still required human to human trading continuing their centuries of practice. Before computers that was the case everywhere but computers changed that. Computers came into the offices and back rooms of the NYSE. But only humans trading on the floor.

Technology enabled insider trading!

Once technology entered the arena, electronic speeds soon outpaced humans. HFT technology uses that speed advantage to pick off orders with stale prices. Stale prices happen when a buyer or seller is not aware or up to date on a price change. That makes the old price stale.

When price changes happen, even with electronic trading, it takes time for the prices to flow to all users. It may take mere milliseconds, but when prices change, the price on a given order can be too low or high for a window of time.

Before humans see let alone react to a new price, HFT seize the opportunity. HFT systems see the opportunity, place an order and executes the trade. We get our pocket picked. We lost a race and did not even know we were in the race!

That can happen on every trade! There are millions of such instances each day! HFT can see price changes and opportunities before any human investor becomes aware. That speed advantage lets HFT step in front of any investor on any order to make a guaranteed profit.

The HFT wizards invented an equivalent of technology-enabled insider trading! Lesson 6 details how HFT does that within the regulations and t he law! HFT uses technology power to run circles around investors and the law!

High frequency trading uses technology power and secrecy for huge advantages over investors

Developed in secret, HFT uses cutting edge technology for huge head starts over investors. Lining up communications, computers and coding together leaves investors far behind. That combination has the effect of a predatory tax on investor trades in the market. In that way the clever scheme takes from many to put profits into the pockets of the few HFT wizards.

Those few private pockets have profits aplenty but none to share with you! Such developments tilt stock markets against investors. Knowing and understanding these issues prepares investors to manage these HFT risks. Later lessons in this course teaches how to protect portfolios from HFT predators.

AI applies and grows from deep learning

Applying deep learning, AI programs digest and link the masses of data to trade outcomes. They learn! Even scarier, while we blink, they learn much faster than we do or can.

Now scientists work to improve trade result predictions and develop error connection. Programs are smart and continue getting smarter! Quibble if you like about it not yet being true AI. However, such developments are well on the way to transforming the economy and our future.

AI algorithms are loose in the cloud untied to any particular computer. That opens further mind boggling possibilities. Such developments make what was unimaginable now possible.

When will powerful faceless programs impact markets, investing and economies? Do they now? The machines are here! Sobering thoughts for a future now here!

Options show electronic trading success

To understand HFT it is useful to look at markets before it became a significant market force. A long established market using electronic trading shows useful facts of trading life. Years before HFT, options markets switched to electronic trading. In options trading that change was a spectacular success.

NYSE management was well aware of the success of electronic options trading. And they were aware of electronic trading success in other markets. Still, it took the financial crisis of 2008 for the NYSE to change. Until then, the entrenched culture remained determined to resist electronic trading. But threats to profits soon changed attitudes.

Well established electronic trading success in the options market showed the way. To understand how a quick look at the options markets makes it clear. Years of electronic trading use by options markets provided clear evidence of success. That market got important and profitable benefits from electronic trading technology.

Electronic trading changes options markets

Three dramatic changes happened when option pricing and trading went electronic. When all players got full and timely price information three significant changes happened:

1. Volumes increased

​2. Spreads narrowed

3. Volatility decreased

​

Years before HFT e xisted, options markets switched from human to electronic trading. That change benefited option traders and markets. There was a notable increase in transaction speeds. As more transactions happened faster, trade volumes grew.

Price transparency grows options volume

Before electronic trading, options players had to deal with uneven price information. That was a side effect of how price information moved. Players passed prices from one another over time. Obviously, that produced a delay and put some at a disadvantage.

Anyone unsure about price information turns cautious. That is normal at the grocery store or in options markets. Cautious buyers and sellers trade less often and in smaller amounts. Electronic trading changed the game. Electronic trading gave everyone the same price information at the same time.

Electronic trading leveled the price playing field and caused a huge change. All players could see clear accurate and complete price information. And they all got it at the same time.

Price information included the amount or dollar value at each price. As well, everyone could see the number of orders and the volume each bid or asked at each price.

Option markets speed up

Options players learned to trust the complete price information and act faster. Any buyer or seller could move their order and narrow the spread or accept a trade. Any player could seize an opportunity to buy or sell.

With faster action both competition and volume increased. Price spreads narrowed with competition. Price spreads are the difference between the price a buyer bids or offers and the price a seller asks.

Volatility - price swings slowed and narrowed 

Electronic trading had another effect in the options markets. It changed volatility. Volatility measures price swings, the amount a price moves over time. Less shows a calm market, more displays an anxious market.

As volume increased and spreads narrowed, volatility slowed. It declined when all players got full price information at the same time. Price swings continued but were less extreme.

High frequency trading claims mythical electronic trading benefits

HFT advocates love to claim responsibility for electronic trading benefits that existed before HFT ever did. That mythical twist is just one of many bits of HFT misinformation. None of these electronic trading changes or benefits owe anything to HFT. Electronic trading does not need or depend on HFT. But HFT does have complete dependence on electronic trading. HFT is a form of an automatic electronic trading system. ​See lesson 11 for further discussion of Myths and misinformation from high frequency trading.

Wrapping the lesson together

To lay a base understanding of HFT this lesson covered a broad sweep of points. Coming lessons will build on that base to give you much more depth and breadth. To wrap this one together the principle points follow.

Technology is core to the development and success of HFT. Those technologies include advanced communications, cutting edge computing and programming advances. Using those technologies gives HFT a huge edge on investors. These technologies put even the most sophisticated human investors at a disadvantage. Such technologies reach beyond the abilities of any human.

The approval of computerized trading by the SEC in 2008 opened markets to HFT. As HFT invaded markets, no financial service company informed or helped investors understand. None has helped investors deal with the effects of HFT.

The development and deployment of HFT systems happened quietly. They were turned loose on investors as an insider play. And HFT got lots of insider help. That ensured technology powered HFT could turn market forces on their head.

In a world of 30,000 HFT trades able to happen in a blink of an eye, things changed. Those profit grabbing systems are magnitudes faster than any investor. Stale price picking and other HFT strategies in coming lessons leave investors behind.

High Frequency Trading taxes investors!

The cost HFT imposes on investors is like a tax. It comes from the changes that have the startling effect of imposing a layer of cost across markets. Those costs exploit all investors to pour profits into the pockets of the HFT wizards. Spreading costs while picking up profits certainly demonstrates how HFT uses technology power.

The race for profit makes HFT systems compete with one another. That competition spurs further technology development as we hurl into the future. Developments include moving towards AI as technology reaches into our pockets and portfolios.

Finally, the lesson tells the option market story of success. It was electronic trading, not HFT that delivered the success. The benefits and advantages ar e not the doings of HFT. The option market success shows this. Electronic trading benefits and advantages are separate from HFT. HFT is a form of computerized electronic trading. It is not the reason electronic trading offers benefits and advantages.

Understanding the HFT technology edge lets us understand the power of HFT. That prepares us to learn how to deal with it. Doing that keeps money in our pockets and working for us. Lessons in this course teach how.