A Brief Summary of High Frequency Traders

The human brain is a wonderful thing, but it does have limitations in the speed in which it can process information. It is estimated humans can process simple external stimuli in a space of 250 milliseconds. Lets take this to be the outer boundary for humans to participate in responsive thinking. This 250ms window is where algorithmic trading dominates and creates its edge over the rest of the market.

In the last post, we saw that over 70% of traded securities in US markets are traded by algorithms. A subset of algorithmic trading is high frequency trading. High Frequency Trading companies have spent millions of dollars to store these algorithms in interconnected servers as close to the stock exchanges as possible for the sole purpose of receiving information before anyone else (about prices). It is a world where the speed of light is something one must factor when making calculations.

One of the fastest hardware trade execution algorithms takes about 740 nanoseconds to make a trade. It is difficult to picture this since it's on a time scale humans can't really conceive. A nanosecond is a billionth of a second and to put into context, it takes about 740 nanoseconds for light to travel 11.8 inches. High frequency traders operate on these timescales.

BUT these algorithms aren't very smart. On May 6th, 2010 at 2:45 PM: The algorithms in the US market decided to make some controversial decisions. While the markets were having a slow day, the algorithms  decided they were going to take almost a trillion dollars of capitalisation out of the global financial markets. They traded Accenture stock for 1 cent a share and decided Sotheby's would trade for over $100,000 dollars a share. Then 15 minutes later, they decided that everything was going to go back to normal. Whats most frightening about this is the fact that we still do not know what fundamentally happened in those 15 minutes even today.

Although these algorithms have created a wealth of opportunity in a field of study known for its profitableness, they pose some alarming concerns. There are millions of algorithms in the market we do not understand, operating on time scales inconceivable to humans, influencing prices of not only stocks but commodities like oil. The same oil we use as gasoline in our cars everyday. It begs the question whether or not we are living in a world controlled by these machines.

Writing References:

https://en.wikipedia.org/wiki/2010_Flash_Crash
https://www.capgemini.com/resource-file-access/resource/pdf/High_Frequency_Trading__Evolution_and_the_Future.pdf

Image References: 

http://i2.cdn.turner.com/money/2010/10/01/markets/SEC_CFTC_flash_crash/chart_dow_dip2.top.gif
http://www.transworldfutures.com/images/ex_hosting.png