Sunday, May 6, 2012

Who made the investment decisions for HFTs: people or computers?


2:45 pm May 6, 2010, with the Dow Jones down more than 300 points for the day, the equity market began to fall rapidly, dropping more than 600 points in 5 minutes for an almost 1000 point loss on the day by 2:47 pm. Twenty minutes later, by 3:07 pm, the market had regained most of the 600 point drop.


This May 6, 2010 Flash Crash or The Flash Crash was the second largest point swing with almost 1010 points in Dow Jones Industrial Average history. It was also the biggest one-day point decline with 998.5 points.

CNBC Coverage of the Dow 1000 Point Plunge - "Machine Error"


What made this happened? Why did the financial markets experience such huge fluctuation in just twenty minutes? After five months of investigation, the U.S. Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) issued a joint report (FINDINGS REGARDING THE MARKET EVENTS OF MAY 6, 2010). The report attributed the decline to Sell Algorithm and HFTs. The trades of E-Mini S&P 500 from Sell Algorithm dropped the market 3% in the first four minutes, and then followed by the huge trade of HFTs. Most of trades were triggered by the computer, who detected the arbitrage opportunities or stop loss requirements, then launched tremendous orders in just several minutes.

So what is HFTs? Why do they have such huge effect on the financial markets? HFT, High-frequency trading, is to use complex technological tools to trade securities like stocks or options. Generally speaking, HFTs employed computerized algorithms to analyze incoming market data and traded in large quantities within very short period. The purpose of their trade is to trade them immediately, but not to hold the position. They gain profits by accumulating very small money from every trade. At the end of a trading day, they generally hold no net position. 

                                                                        
                                                                                                What is high frequency trading?


Since HFTs are very sensitive to the processing speed of markets and of their own access to the market, they highly rely on the information and communication technology. They compete with each other on a basis of speed. HFTs use the best technology to communicate information and the fastest computers to process market information. "It's become a technological arms race, and what separates winners and losers is how fast they can move," said Joseph M. Mecane of NYSE Euronext, which operates the New York Stock Exchange(Stock Traders Find Speed Pays, in Milliseconds).  Also please listen the interview audio from Charles Duhigg on HFTs.



High-Frequency Trading:- Corporate super computers cornering share markets

With advancement of information and communication technolgoy, HFTs are experiencing rapid development. In 2009, they accounted for 60 percent of the daily U.S. stock market volume of 9.8 billion shares and about 40 percent of futures and foreign-exchange trading (Trading Pennies Into $7 Billion Drives High-Frequency’s Cowboys).



At the end of day, through high frequency trading people may win a lot of money, however, they may also lose tons of money. But why do people make or lose money? It is by people themselves, or by computers. Is it competition between people, or race between machines? Who made the investment decision? In the future digital marketplaces, people need to think about the relation between people and machines.