Jargon Busting with Hawksmoor: High Frequency Trading
Written by Ian Woolley, CFA, Senior Investment Analyst. Feature Photo by OTA Photos
The Hound of Hounslow is not a Sherlock Homes novel, but the true story of how one man and his algorithm in West London allegedly managed to temporarily wipe $1trillion from US stock markets in minutes. Welcome to the age of High Frequency Trading (HFT).
HFT is stock market battling by complex algorithms at lightning fast speeds. It takes a supercomputer about 10 microseconds to complete a transaction; operating at that speed at the supermarket self-checkout, you could buy your entire lifetime grocery list in under a second (to the jangle of “please place the items in the bagging area”).
The impact to financial markets has been phenomenal: most trades now originate from lines of computer code. Proponents argue HFT improves liquidity and lowers costs. The seller of a large holding would be ill-advised to dump all of their shares in one go. Instead, an algorithm could drip-feed the order into the market over time, responding to buyer volume.
However, HFT abuses are well-documented. In May 2010, Navinder “The Hound of Hounslow” Sarao created $200m of fake sell orders that cancelled before execution to dupe other HFT algorithms
to sell for real. This allegedly caused the 2010 “Flash Crash”, exposed the shaky foundations of our hyper-speed, computer-dominated financial markets, and made Mr Sarao a fortune.
Markets exist for companies to raise finance and investors to efficiently allocate capital. HFT has brought clear advantages, though its risks must be tempered to ensure markets can continue to fulfil
those primary purposes.
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