High Frequency Trading: Should you be Scared?

Taking algorithmic trading to new levels, High Frequency Trading (HFT) is software driven trading experience, in which minimal human handling is required. The speeds at which trades are executed are mind boggling, much faster than you can even blink. HFT systems are highly complicated and programmed to recognize trends, build strategies and carry out trades. Access to such systems is limited to a few hands as masses don’t even know for sure that such technology exists. Even expert traders and retail investors, who know of HFT, can only dream of benefiting from these instruments due to affordability factor.

Powerful Trade Engines can Derail Retail Wagon

HFT systems can run algorithms in an ultra fast mode and identify stock price equilibrium to capitalize on tiny price fluctuations. These allow traders to place and cancel trades in seconds, requiring one click per command and thus making it difficult for retail participants to know what’s happening. Profits from such trades are pretty small, but really quick and frequent, enabling privileged users to generate handsome returns in each trading session, without having to hold any overnight positions. A major drawback with HFT is that traders using this technology simply close all their positions before market close and escape the risk of holding equity in a business, thus all the burden is borne by retail investors. HFT is a gateway to a new era of financial world, where high-end expensive technology makes it an unfair game-play, as retail masses remain poorly equipped to face the new system. However, there are equally convincing standpoints related to impact of HFT on the overall stability of an economy.

Off the cliff with Flash Selling

One worry is that HFT firms can take the exit route in a flash, if concerned due to any market related issue, which can lead a stock to crash instantly, taking out retail investors by surprise. Most HFT firms are large hedge funds and financial organizations who get the advantage of access to valuable data from stock exchanges, and with such fast pace technology they can create volatility that is impossible to deal with for the retail crowd. Trouble for retail investors not just end yet, as increased volatility produces erroneous trading signals on the charts that mislead investors to latch on to wrong trades. Moreover, the liquidity provided by HFT is of substandard nature as it does not offer any support to the market. A challengeable aspect of HFT is that few privileged traders get the complete details of market order flow, which is not available to retail investors, and can be used to manipulate markets. This creates a situation in which the probability of suffering losses for retail participant increases multi-folds.

The Bright Side to High Speeds

But if we look at HFT from the point of view of someone who uses this platform, the picture will shape up entirely opposite. Some consider HFT to be highly beneficial for retail investors as it helps in transparent pricing of stocks and at the same time protects stock markets from systemic risks by enhancing liquidity. However, these highly competitive trading tools are designed to equip professional players with lightning fast algorithmic trading in order to take advantage of price abnormalities with super powerful technology.

Conclusion

High frequency trading is potentially, more of a riskier bet than what can be achieved through it. No doubt, it enhances liquidity but critics are already questioning if the quality of such liquidity is worth it all? Moreover, high frequency trading is so powerful that it an move the entire market in a particular direction even if the fundamentals and technical does suggest something else. To conclude, I would say that HFT is a powerful weapon, which when used deliberately to manipulate markets, can prove most harmful for retail investors. And if regulators feel that this sort of trading is necessary for the markets, then all attempts should be made to make it a level battle field by providing same resources to retail investors and traders.

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