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11 02 2015 | by Victor Xing | Capital Markets

High frequency trading – what are the pros and cons?

High frequency trading benefits exchanges at the cost of investors.  Their activities reduce market liquidity and increase execution cost.

High frequency trading generally result in higher commission for exchanges, as outlined in Michael Lewis’ book Flash Boys: A Wall Street Revolt.  However, many HFT outfits have co-locating programs, that is, their trading algorithms are housed in the same building as exchanges’ market-making programs.  When an investor hits “trade / execute” on their electronic trading platform, it sends signals to multiple exchanges that may arrive at different times.

If a buy request arrives first at Exchange A, HFT’s program will send another signal to Exchange B to begin lifting prices before the buy request is received by Exchange B.  This speed advantage is thanks to more efficient network routing paid for by the HFT firms, and it is completely legal.

Because of this “feature,” large asset managers (who manage pension funds, 401K contributions as well as mutual funds) will end up executing at a higher cost (less attractive prices), and HFT may quickly stop trading amid heightened market volatility events to exacerbate poor liquidity conditions.

This book is an excellent read

Michael Lewis' book on high frequency trading
Michael Lewis’ book on high frequency trading

Next article10 27 2015 | by Victor Xing | Central Banks

What are Janet Yellen’s strengths as the FED Chair?